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MM Asia Financials Asia Banking 2025: Digitalisation to Redefine the New Normal Falling rates are driving down returns. As digital adoption accelerates amid COVID-19, minimal investments and poor execution discipline could lead to a 4- 5% ROE gap vs digital leaders by 2025, and banks missing estimates. Banks should act now to secure competitive success and shareholder returns. Morgan Stanley does and seeks to do business with companies covered in Morgan Stanley Research. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of Morgan Stanley Research. Investors should consider Morgan Stanley Research as only a single factor in making their investment decision. For analyst certification and other important disclosures, refer to the Disclosure Section, located at the end of this report. + = Analysts employed by non-U.S. affiliates are not registered with FINRA, may not be associated persons of the member and may not be subject to NASD/NYSE restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account. MM Contributors MORGAN STANLEY OLIVER WYMAN Nick Lord 1 Dan Jones EQUITY ANALYST PARTNER +65 6834-6746 +852 2201 1704 [email protected] Richard Xu, CFA 2 EQUITY ANALYST Anirudh Singh +852 2848-6729 PARTNER +60 (3) 2302 8577 Joon Seok 3 [email protected] EQUITY ANALYST +82 2 399-4934 Seo Young Lee PARTNER Sumeet Kariwala 4 +81 (70) 4552 4002 EQUITY ANALYST [email protected] +91 22 6118-2235 Jacob Hook Mulya Chandra, CFA 5 MANAGING PARTNER EQUITY ANALYST +61 (2) 8864 6525 +62 21 3048-8125 [email protected] Subramanian Iyer 4 Marc Entwistle EQUITY ANALYST PRINCIPAL +91 22 6118-2234 +852 2201 1775 [email protected] Irene Zhou, CFA 2 EQUITY ANALYST Yutao Guo +852 2848-6526 +86 1861 6105 605 [email protected] Selvie Jusman, CFA 1 EQUITY ANALYST Toni Miharja +65 6834-6517 +65 6510 9465 [email protected] 1 MORGAN STANLEY ASIA (SINGAPORE) PTE.+ 2 MORGAN STANLEY ASIA LIMITED+ 3 MORGAN STANLEY & CO. INTERNATIONAL PLC, SEOUL BRANCH+ 4 MORGAN STANLEY INDIA COMPANY PRIVATE LIMITED+ 5 PT. MORGAN STANLEY SEKURITAS INDONESIA+ MM Contents 4 Messages for the C-Suite 6 Key Takeaways from our AlphaWise Survey 8 Digitalisation of Asian Banking MM Messages for the C-Suite Asian banks' growth and profitability were strong in the years leading These changes mean that a bank’s traditional response to lower up to 2020. However, this success may not be a good guide for the rates, such as increasing asset spreads and focusing on new fee strat- future, and the ongoing COVID-19 crisis has put the resilience of the egies, might not work over the next five years, especially as changing banking sector to test. During the pandemic, we have observed reve- digital preferences create opportunities for new entrants. Our anal- nues missing forecasts, increased scrutiny on operating expenses, ysis looks in detail at the potential revenue benefits from digitalisa- higher cost of credit and a greater strain on infrastructure across tion, acting as a useful offset to broader revenue pressures due to banks in Asia. lower rates, with banks in India, Indonesia and China potentially seeing the most benefit. Despite the hype surrounding digitalisation, Whilst some of these pressures will recede with the pandemic, low the large driver of incremental returns from digitalisation and poten- interest rates are likely here to stay and will continue to put material tial cost savings may not be sufficient to hold up returns, especially pressure on bank returns. Our estimates show ROE in 2025 below in developed markets, where net interest margin (NIM) pressures are 2019 levels for all country/market/region sectors, with the exception most intense. of India (led by credit cost normalisation). Falls are particularly mean- ingful for banks in Korea, Singapore, Hong Kong and Thailand. Our analysis quantifies the impact on returns by three key pillars: Banks will therefore need to start or accelerate their transformation l Growth: The ability to capture an increased share of the market journeys. Given the limited levers banks have to pull, digitalisation size by accessing new customer segments and driving financial has emerged as one of the highest priority strategies for Asian banks inclusion, and to take market share from competitors for digitally looking to recover and return to growth. The question is whether or savvy customers, while defending existing customer bases and not this will be sufficient. margins from fintechs and digital challengers l Efficiency: The ability to streamline, redesign and automate sys- Fundamental behaviour changes of customers and employees alike tems and processes to drive efficiency and cost/scale benefits, have fast-tracked banks’ digital development. leveraging systems and technology effectively, leading to enhanced profitability l Retail customers have rapidly adapted to digital channels to fulfil l Resilience: The ability to insulate the business from future shocks financial needs during periods of social distancing. Consumers are and continuing to serve customers in a safe, secure, scalable becoming keener on value-added digital services and products. manner in the face of increasing risk and an uncertain economic Sharp growth in digital payments is under way, particularly outlook amongst digitally advanced economies. l SME customers, a generally underserved segment, are shifting We estimate that the net growth impact on returns could add their preference towards digital channels. Access to credit con- between 0.1-0.7% to ROE via higher income, with emerging markets tinues to be a top need, as are increased expectations for ease of banks in India and Indonesia having the most to gain, while banks in access to broader financial servicing needs via digital channels. Singapore and Hong Kong have the least to gain. However, these net l Corporate customers are increasingly expecting a broader range income gains are relatively small in terms of the revenue headwinds of offerings from banks, such as digital on-boarding, advisory, dig- banks face from lower rates. We expect that the fall in revenues as ital sector solutions and fintech partnerships. They expect more a result of COVID-19, and in particular, lower rates, could take efficient and seamless end-to-end digital services, which most between 1.5-6.6% off ROE, with banks in more developed markets, banks are struggling to provide. plus Thailand, among the most impacted and Chinese and Indian l Bank employees have adopted work from home routines, with banks the least impacted. While the growth benefits from digitalisa- many organisations planning ongoing flexible arrangements post tion will be relatively small compared to the revenue headwinds COVID-19. To facilitate sustained efficiency and flexibility, banking banks face, we still believe that banks need to act, as the conse- operating models and decision-making processes need to be re- quence of not doing so would mean ceding ground to new entrants, designed. potentially making revenue headwinds far worse. 4 MM The bigger benefit to returns potentially comes from lower costs, pacity, with the potential to actually cut net costs whilst providing with banks adding up to 0.7% to ROE from efficiency digitalisation greater control and resilience. This impact is relatively small in the gains. Once again, banks in Indonesia and India could benefit the context of overall forecast ROE movements. most. However, we estimate that these benefits will account for only up to 78% of the cost efficiencies we believe banks will achieve over Overall we believe the digital leaders of today have the opportunity the next five years. In the face of expected revenue headwinds, not to capitalise on the headstart they have in their digitalisation journey only will banks need to deliver on these digitalisation gains, but they to maximise efficiency gains and defend against emerging risks will also need to deliver further streamlining to meet market expec- including the acceleration of client expectations, regulatory driven tations. The biggest challenge here is likely to come for banks in change and new market entrants. The digital leaders of tomorrow Thailand, Korea and Singapore. Banks in mainland China, India and can deliver up to 4-5% higher ROE than the slow adopters, but this Indonesia would appear to have more headroom. Hong Kong banks will require concerted efforts to scale and accelerate the transforma- face similar challenges to Singapore banks, except that our forecasts tion roadmap, upgrade digital capabilities and capture emerging already incorporate an increase in cost-to-income ratios. growth opportunities. Meanwhile, slow adopters face a complex, multi-year digital transformation journey, risking an increasing gap in Finally, we note that resilience impact will be a drag on ROE. ROE vs the digital leaders and a rapid deterioration in shareholder Significant human capital has been invested into risk-related controls value. over the past decade, and digitalisation will help unwind that overca- MORGAN STANLEY RESEARCH 5 MM Key Takeaways from our AlphaWise Survey Overview of the survey: As part of the research process undertaken l Contrary to our expectations of falling returns, banks expect to in compiling this report, we have surveyed banks across Asia from return to pre-COVID-19 levels of profitability, although they think August 25 to September 8, 2020. We got responses from 21 senior this will take 18 to 24 months. management across 17 banks. 60% of the businesses were domesti- l In terms of new competition, many banks are confident they can cally focussed, 30% had a regional focus and 10% were global; we hold their own. SuperApps are perceived to be a bigger threat than believe that this is a fair representation of the banking sector in Asia.