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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.
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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. pure digital disruptors. 8 out of 13 of banks also agree that We also saw a good geographic spread, with ~20% of respondents COVID-19 accelerates the move of digital disruptors into the from each of Singapore, Indonesia, India and South Korea. Banks from market. Thailand, Malaysia and Hong Kong also responded. Whilst the spread l For the overwhelming number of banks, investing in their own of respondents is good , the sample size is small, thus the results organisation and building internal technological capabilities is the should be read more qualitatively, rather than quantitatively. We priority. Following that, banks favour partnerships with third par- summarise the key observations / takeaways below: ties followed by strategies to enter new markets. Developing new models, or ventures to take on digital disruptors head on, is the l Banks expect retail/household lending and SME revenues to be least popular strategy. More specifically for SME and corporate most impacted by COVID-19. The main drivers of lower retail/ banking, the focus of investment will be data-led decision-making, household lending revenues were expected to be higher unem- with new digital ventures well down the priority list. ployment, movement restriction and declining consumer l Banks universally agree with the statements that digitalisation confidence. For SMEs, lower confidence and movement restric- efforts will help lift ROE and ROA, and all agree that branch, man- tions were the main challenges. power and overall operating costs will fall, which tallies with our l A large majority of banks expect marketing costs to fall over the view. The vast majority also agree that top line and balance sheet next 12 months, with over 50% seeing a fall in occupancy (8 out of growth will benefit from digitalisation, and that credit costs 13 respondents) and staff costs (6 out of 13 respondents). All should improve, however, there is not a universal agreement here. banks see IT costs increasing or staying the same. 6 out of 13 banks expect to increase IT investment over the next five years; no one expects to reduce it.
Exhibit 1: Exhibit 2: Overwhelmingly, banks see retail/household lending and SME lending Staff and marketing costs will be main source of savings in next 12 as being most impacted by COVID-19 (base=14 respondents) months; IT costs are expected to increase (base=14 respondents)
Source: AlphaWise, Morgan Stanley Research.
Source: AlphaWise, Morgan Stanley Research.
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Exhibit 3: Exhibit 4: Banks expect profitability to return to pre-COVID-19 levels, but many Banks see a bigger threat from Super App players than pure digital expect this will take 18-24 months (base=11 respondents) banks in terms of leading growth in the next five years (base=13 respondents)
Source: AlphaWise, Morgan Stanley Research. Source: AlphaWise, Morgan Stanley Research.
Exhibit 5: Exhibit 6: Digital disruptors benefit from COVID-19 (base=15 respondents) Internal investment followed by third-party partnerships are the most popular strategies (base=14 respondents)
Source: AlphaWise, Morgan Stanley Research.
Source: AlphaWise, Morgan Stanley Research.
MORGAN STANLEY RESEARCH 7 MM Digitalisation of Asian Banking
Section 1. Setting the scene – the “new more recently, these returns have been under pressure, especially relative to North America. Across multiple measures, we have seen normal” post-pandemic Asia making large strides towards delivering sustainable growth within this rapidly evolving industry. The proliferation of the COVID-19 pandemic has brought about unprecedented social and economic disruption on a global scale. However, past and present success may not be a good guide to Rapid digitalisation of the financial services sector has been at the the future. The ongoing COVID-19 crisis has put the resilience of centre of this change, putting industry participants’ agility and resil- the banking sector to the test and questions are being asked ience to test. New market entrants may benefit from an accelerated about how the sector will emerge from the crisis. We have seen shift to digital, counterbalanced by lesser experience withstanding increased leverage, not only private sector debt to GDP, as income crises and compounded by fragile balance sheets and strains in levels fall, but also in the only unstretched part of the balance sheet funding. So where are we likely to see the most change, and who is – the public sector – given the significant fiscal easing. Whilst this is best positioned to capitalise on this new normal? necessary now, we believe it will lead to headwinds for future growth for economies and the banking sector, leaving Asia with smaller room Before the pandemic hit, Asian banking growth and profitability for government intervention in the next downturn. This could also had been strong. Despite global headwinds in the past few years, lead to unconventional monetary policies, which may have implica- ranging from US-China trade tensions, uncertainty over the direction tions for future NIM and ROE in the sector. of the EU and a short-term hit to oil prices, among others, major Asian banking markets (based on eight major Asian markets, namely Hong The changing face of globalisation, in particular the need to duplicate Kong, Singapore, South Korea, Indonesia, Thailand, Malaysia, India supply chains, is lowering cost benefits to south and southeast Asian and mainland China) have grown faster than other regions in terms economies. More broadly, we see that the decoupling between US/ of overall assets, recording a ~7% CAGR in 2015-19 as compared China and geopolitical tensions will make it more difficult to extract with Europe and North America at ~3% and ~4%, respectively. On growth from the next cycle, whilst also lowering economics of scale, profitability, Asian banks have maintained a healthy average raising costs across the economy and potentially lowering profit- return on equity of ~10% in the past 10 years, above the 10-year ability. China's localisation efforts also appear to be making its average ROE of Europe at ~4% and North America at ~9%, although, growth less complementary for the rest of Asia.
Exhibit 7: Total banking assets in select Asian markets, 2010-19 (USD tn)
Source: BMI.
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The post-COVID-19 environment for banks will there- Exhibit 8: fore be far more difficult. Banks’ asset quality has Asian banks' ROE projections already been impacted and will likely translate to greater risk aversion, acting as a further drag on bal- ance sheet growth and returns. In addition, a lower interest rate environment and pressure on fee reve- nues will also mean it will take longer for returns to recover.
Our forecasts indicate that ROE is not expected to recover for any of the Asian country sectors we look at, with the exception of India, which benefits from a non- performing loan (NPL) recovery cycle over the past five to seven years. The cost of credit is expected to continue decreasing, resulting in ROE incremental uplift. The expected shortfall in ROA is most acute for Source: Morgan Stanley Research. E = Morgan Stanley Research estimates. Note: *ROE for India was >12% before 2016. ROE Indonesia, Thailand, Hong Kong and Korea ( Exhibit 8 ). dropped in 2017 due to a surge in NPL. Since then, India underwent an NPL recovery cycle. We expect cost of credit to continue decreasing, driving incremental ROE lift post-pandemic. Indonesia may expect less pressure at the ROE level as we see an expected increase in leverage in upcoming years, driven by acceleration of loan growth, partly with the digitalisation of lending products.
Asia will be the testing ground for the world's Exhibit 9: COVID-19 response. Much of this adaptation is highly Three key objectives in digitalisation operational, with social distancing practices, for example, leading to significant changes in customer behaviour, such as a shift to digital banking channels and workplace business continuity challenges. In response to these changes, many leading institutions have embarked on transformation journeys – our sur- veyed bank executives agree that “radical change is available” and “the biggest mistake we can make is to go back to our former business model” (Source: Oliver Wyman interview with a senior executive of a leading global bank).
As recovery strategies crystallise, digitalising the organisation has emerged as the highest priority of the post-COVID-19 agenda for many Asian banks Source: Oliver Wyman. looking to return to growth. We see three objectives at the centre of rethinking the "new normal"; Asian banks must refocus digital transformation programs post-pandemic in order to capture opportunities and defend tangible revenue streams (growth), take costs out (efficiency) and strengthen risk control (resilience) – summarised in Exhibit 9 .
MORGAN STANLEY RESEARCH 9 MM Section 2: What's next – the drivers of It is perhaps unsurprising that mobile channels have seen the highest growth in usage. In 2Q results, the Hong Kong banks highlighted that change and implications the number of mobile bank users had increased by between 23% and 47% YoY, whilst digital wealth sales were up by 38-68%. Emerging Given the macro changes and prolonged duration of COVID-19, a shift markets such as Indonesia have also experienced a strong swing to of this magnitude will inevitably change businesses, the society and digital engagement, with internet and mobile banking channel usage the global economy in many ways. Under the new normal, we believe increasing up to 60% during the pandemic (Source: Company disclo- the profound impacts brought by the pandemic could fast-track dig- sures as seen in The Jakarta Post). ital developments, especially in emerging markets. Sharp growth in digital payments 2.1 Retail Customers Digital payments have experienced strong growth in Asia and further Rapid adoption of digital channels by consumers to fulfil finan- accelerated during COVID-19. In April, the Association of Banks in cial needs Singapore announced that the amounts transferred with Singapore’s PayNow Corporate service, a platform for cashless transactions, saw Digital channels will become a major channel for end-consumers a 713% year-on-year jump in February to S$3.12 billion. Emerging mar- with increasing digital needs and expectations. After social dis- kets have also experienced accelerated adoption of e-payments, such tancing measures were imposed, a leading Asian bank saw a 100 mil- as Thailand’s PromptPay platform, which according to company dis- lion uplift in digital transactions compared to 2019 and 10,000 new closures as cited in The Bangkok Post processed up to 11mn transac- account applications received within three days of limited branch tions per day in March 2020, achieving almost 100% growth access. Southeast Asian banks are seeing 200+% growth in online compared to the same period last year. investment accounts, opening and usage (Source: Oliver Wyman dis- cussions with banks).
Exhibit 10: Percentage of consumers planning to spend more online over the next 12 months, from February 2020
Source: Tofugear survey (February 2020).
10 MM A key driver of this growth has been the shift from physical stores to 2.2 SME e-commerce. There has been >100% growth in digital payment usage across developed Asian markets and >250% growth across emerging Opportunity to serve the traditionally underserved SME seg- Asian markets. Surveyed at the onset of the pandemic, more than ment digitally 40% of consumers anticipate spending more online over the next 12 months across major Asian markets (Source: Tofugear survey SMEs demonstrated a preference for digital servicing before the (February 2020)) ( Exhibit 10 ). arrival of the pandemic. While more than 50% of Asian SMEs already look for new credit lines via digital channels, approximately 20% of Growing demand for value-added digital services and products SMEs were able to complete the process online to submit their loan application ( Exhibit 11 ). SMEs are more willing to adopt online There is a distinct opportunity for banks to capitalise on the growing channels as the primary channel to discover and apply for credit demand for digital services and improve stickiness through product offers, but the supply side is falling short in enabling an end-to-end and service innovation. In mainland China, Ping An Insurance intro- online credit application procedure. duced the “Do It At Home” campaign offering smart and contactless services across most of its online financial products, ranging from We believe that banking players will need to move “beyond banking” wealth management to insurance. Within two weeks, over three mil- with their retail and SME value propositions to defend against the lion customers had made more than 11 million transactions and its threat of new challengers. A wide array of digital offerings can be online lectures attracted over 470,000 viewers (Source: Company offered to SMEs to support not only their financial needs but also disclosures). The three largest Singaporean banks also saw a sharp business needs ( Exhibit 12 ). For example, leading banks are intro- rise in digital transactions, digital account opening and usage of robo- ducing online accounting and cash flow management solutions lever- advisory financial planning services in the same period. aging data analytics, enabling event-based bespoke offers, or group Robo-advisory investments between January and March 2020 purchasing platforms that help SMEs reduce supply chain costs. grew 60% compared to October to December 2019 (Source: Straits Similar to retail customers, SMEs are increasingly using digital chan- Times, May 2020). nels for payments and transactions, an area where banks will need further focus to improve coverage of SME banking. COVID-19 has accelerated digital adoption and changed customer preferences and expectations for banking services. It is paramount that banks quickly adapt to consumers’ behavioural changes and work to retain and expand upon the digitalisation gains made post-re- covery.
Exhibit 11: Channel preferences for loan applications in Asia
Source: Oliver Wyman SME Banking in Asia Pacific Survey 2017, Oliver Wyman analysis. 1. South Korea and Mainland China are out of scope in the survey.
MORGAN STANLEY RESEARCH 11 MM Growing demand for value-added adjacent non-banking digital services
Exhibit 12: An array of digital offerings catering to SMEs to support business and financial needs
Source: Oliver Wyman.
Opportunity to retain SME customers beyond COVID-19 relationships may well be better placed to support against new market entrants competing on a price basis. A further consideration will be the extent to which the assistance provided by banks to SMEs during the COVID-19 crisis increases SME Whilst SME banking has been a historically underserved segment, it stickiness. Banks have offered repayment holidays or bridging loans stands as a large growth opportunity in the digital era. Banks should to many SME customers, either as part of their own customer relief leverage digital capabilities to offer improved lending solutions to schemes, or at the behest of respective governments. As we emerge SMEs, at the risk of leaving this opportunity open to new market from this crisis, banks will be instrumental in supporting the sustain- players. Banks should also increase the share of wallet with broader, ability of the SME sector via loan restructuring. Banks that have exer- targeted and more digital offerings for SMEs. cised opportunities to foster loyalty and support their SME
12 MM 2.3 Corporate Customers Exhibit 13: End-to-end digitalisation support requests from corporate clients Whilst the global pandemic has brought tangible impacts to retail and SME segments, there are distinct and less well understood changes to address in corpo- rate banking.
Digital offerings are expected to be one of the greatest emerging clients’ needs post-COVID-19 within Asia
Corporates have increasing needs for short-term liquidity, capital and restructuring, risk management and supply chain integrity. Up to 65% of leading cor- porate banks in Asia view digital sales and advisory as important client needs post-pandemic (Oliver Source: Digital Transformation Blueprint; Oliver Wyman client discussions. Wyman Corporate Banking 2020 Post-Covid Survey). In particular, the top three requests for support from Exhibit 14: corporate clients are for digital advisory, industry Performance skews amongst bank sales force during COVID-19 solutions and partnerships. COVID-19 brings about greater client demand for risk and liquidity topics – we foresee that value-added services, for example, pro- viding online real-time advice with the use of data ana- lytics, will become increasingly important and move from differential to core functionality.
Digital channel usage has accelerated, making vir- tual servicing increasingly mainstream
During the pandemic, leading corporate banks in Asia have seen a spike in digital channel utilisation, with 53% reporting a large increase (>50%) and 45% Source: Oliver Wyman Corporate banking post-COVID survey. reporting a moderate (25-50%) increase (Oliver Wyman Corporate Banking 2020 Post-COVID Improved productivity of virtual meetings despite performance skews Survey). Banks also reported up to a 300% increase in digital onboarding, a 4-6x increase in API volumes More efficient virtual meetings have been observed, with cases of RM efficiency year-on-year across leading institutions and up to a increasing by 30-40%. 86% of banks report that engagement levels in virtual meet- 1,000x increase in digital support volumes, such as ings are at least as high as “in-person meetings”. This is a positive change for corporate chatbots. This spike is mainly driven by increasing dig- banks as RMs can prioritise brief, high-value calls over travel time and lengthy in- ital interactions with RMs and client servicing and is person catch-ups. While productivity of the front office has increased overall, perfor- likely to persist post COVID-19. Delivering on client mance skews are still observed, with top performers generating a large proportion expectations for digital servicing will be key to of revenues ( Exhibit 14 ). increasing share of wallet.
MORGAN STANLEY RESEARCH 13 MM An end-to-end digital servicing model is expected from clients While digital adoption has significantly increased, banks still struggle to meet clients’ expectations Clients are seeking efficiency, with 75% of corporates demanding integrated services across channels and the RM to facilitate a seam- 71% of clients see a digital offering as an important factor in selecting less experience. Approximately 80% of corporate clients already a new banking partner. However the majority of clients (up to 60%) expect banks to interact with them in real time, which underlines the remain dissatisfied with their bank’s current digital proposition. case for a robust end-to-end digital servicing model ( Exhibit 15 ). Beyond traditional banking services, corporate clients are requesting 95% of corporates want an aggregated account view and real-time additional digital offerings from banks. Premium services delivered transaction information but few corporate banking systems are over digital channels are increasingly requested, rather than limited to offering that. To stay competitive, the majority of banks are rapid access to essential services. The majority of banks are under-de- expecting ~50-70% of originations to shift to self-service straight- livering on corporate client expectations, leaving an opportunity to through processing (STP) channels in the next six months. close the gap via digital offerings and achieve market differentiation.
Exhibit 15: High expectation of corporate clients on efficient banking
Source: Oliver Wyman Corporate Banking 2020 post-COVID survey, 2019 CGI Transaction Banking Survey.
14 MM 2.4 Organisational change pandemic as banks are increasingly valuing flexibility to respond to quickly changing business conditions. Social distancing requirements have accelerated flexible working trends, forcing revised ways of working and effectively serving cus- Decision-making needs to be more efficient tomers. With the importance of fast decision-making in times of crisis, firms The remote working model is here to stay have expedited approvals to adjust for changes. Institutions were often able to mobilise quickly to roll out support packages to con- Operating models will need to be re-designed to enable greater effi- sumers and businesses, albeit at a speed which introduced additional ciency and flexibility. During the pandemic, in many markets, up to operational risks. 100% of banks surveyed say that there will be 40–80% of employees have worked from home. Bank employees some changes to their organisational and team management struc- are generally more comfortable with voice and digital interactions ture ( Exhibit 16 ). In addition, 95% of banks report that new ways of but at the same time many also report additional stress and some re-organising and managing teams have enabled them to improve degree of disruption (Source: Celent). efficiencies during the pandemic.
While the degree of acceptance and satisfaction of working from To ensure sustained productivity gains, banks need to institutionalise home varies, many more people are positively considering the sus- positive outcomes to achieve substantial process efficiency gains and tainability of this model. A major bank in Asia has reported that 80% streamlined reporting lines, whilst mitigating for the new opera- of staff working remotely would like to maintain ongoing optionality tional risks that emerge via process automation, compliance moni- to work remotely. We expect that the demand for flexible working toring and workflow management. arrangements in APAC will re-accelerate in the wake of the COVID-19
Exhibit 16: Degree of organisational and team management change expectations
Source: Oliver Wyman Corporate Banking 2020 post-COVID survey.
MORGAN STANLEY RESEARCH 15 MM Section 3: ROE impact – the digitalisation Opportunities multiply as they are seized landscape Banks that are able to effectively leverage digital capabilities will be able to capture significant opportunities moving forward - to not only The accelerated consumer and institutional adoption of digital is wid- find business growth, but also enhance their efficiency and resilience. ening the gap between banks leading and lagging in their digital transformation journeys faster than ever before. In emerging mar- Those that lag behind will find their profitability and growth nega- kets such as Indonesia and India, the difference between the ROE of tively affected – losing out on the opportunity to capture new cus- digital leader banks and slow adopter banks could be as high as 4% tomers, losing existing customers to new entrants and experiencing to 5% by 2025. For more developed markets, while the delta lower margins, at a higher cost base, driven by legacy IT infrastruc- between leading and lagging banks is not as wide due to higher ture and occupancy costs. existing investments in digital across major players, the difference can still be significant at up to 2%. We analysed the degree of impact brought by digitalisation on var- ious drivers of ROE for eight markets across Asia ( Exhibit 18 ). We see several areas of differentiation that we expect to greatly sep- arate digital leaders from slow adopters, which we structure around three key pillars impacting ROE:
Exhibit 17: Three key pillars
• The a ilit to apture a i reased arket size a d pote tiall higher argi s accessing new customer segments and driving financial inclusion Growth • The a ilit to apture arket share fro o petitors hilst defe di g e isti g arket share and margins from fintechs and digital challengers
• The a ilit to strea li e, redesig a d auto ate s ste s a d pro esses to dri e Efficiency efficiency and cost/scale benefits, leveraging technology effectively
• The a ilit to i sulate the usi ess fro future sho ks a d o ti ue to ser e usto ers Resilience in a safe, secure, scalable manner in the face of increasing risk and an uncertain economic outlook
Source: Oliver Wyman.
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Exhibit 18: ROE impact due to digitalisation across markets
Source: Company reports, Oliver Wyman, Morgan Stanley Research.
MORGAN STANLEY RESEARCH 17 MM
Exhibit 19: ROE impact due to digitalisation across markets
Source: Company reports, Oliver Wyman, Morgan Stanley Research.
18 MM 3.1 Growth be able to access credit due to a lack of collateral and are effectively excluded from bank sources of financing. In addition, SMEs' lending In evaluating the potential for growth of banking revenue from digi- needs are often not fully supported for end-to-end digital lending talisation, we take into account three key factors. It is crucial that we journeys (as mentioned in Section 3: ROE impact – the digitalisa- evaluate these factors in their entirety to provide a robust under- tion landscape ). Digitalisation will increase lending penetration to standing of the impact of digitalisation on incumbent banks’ ROE. this underserved segment and achieve an average 0.3% incremental ROE uplift, we estimate.
The impact of digitalisation on the overall A. Market Size Leading banks and digital challengers are already focusing on this volume of services from both new and existing (Volume) Impact large opportunity across all markets. For instance, major banks in customers The impact of digitalisation on a unit fee basis mainland China are tapping into SMEs’ transaction and inventory B. Fee Unit Impact (for example downward pressure on fees unit data to quickly assess the risks of providing SME business loans. from competitors) Digital challengers in India are offering working capital to SMEs, ref- C. Market Share The impact of the entrants of new digital erencing alternative variables to assess borrowers’ creditworthiness. Impact attackers on the market share of incumbents
Digital payment volumes are set to continue their fast growth trend over the next five years A. Market Size (Volume) Impact As covered previously, COVID-19 has accelerated the adoption of dig- Underserved and un-banked retail segments in emerging mar- ital payments for both consumers and SMEs. All markets are under- kets provide large opportunities for growth going transformation from cash to digital payment. In markets such as Thailand, Indonesia and India, with lower credit card ownership, Many emerging markets in Asia continue to have relatively lower cards fees are likely to increase with higher ownership and e-com- banking penetration, owing to infrastructure constraints, making it merce usage. Together with payment fees, leading banks can gain up costly for banks to provide services to semi-urban and rural cus- to a 0.2% increase in ROE, we estimate. The volume growth of credit tomers. Digital banks benefit from lower costs of customer acquisi- cards, however, is likely to be limited by the popularity of e-wallets tion and servicing compared with traditional banks, with a business as an alternative payment vehicle. model that is less reliant on branch distribution and built on more efficient technology infrastructure. Digital business models will The market for wealth management is rapidly expanding with enable incumbent banks to lend to a population that historically has increased accessibility been unprofitable to serve. Digitalisation provides accessible channels for newly affluent cus- In emerging markets such as India and Indonesia, we expect greater tomers to manage their wealth. In particular, new digital products banking penetration and increasing access to loans to the under- and aggregation of pools of funds lower the barrier to purchase for served, driving incremental ROE of ~0.2% from retail net interest individuals who previously could not meet investible-asset require- income. In relatively more developed markets such as Malaysia and ments. We also note that various markets are introducing new poli- Thailand, we expect digitalisation to drive a positive impact on finan- cies to widen wealth management opportunities. China announced a cial inclusion, albeit to a lesser extent, with a potential ROE uplift of pilot scheme in 2020 that allows cross-border sale of investment ~0.1% by 2025. In mature markets such as Singapore, South Korea and financial services between Hong Kong, Macau and mainland and Hong Kong, digital leaders who are already offering robust digital China through digital channels. In markets where consumers are channels to a digital-savvy customer base will be able to better already technology-savvy, robo-advisory and other digital wealth defend their market share against new competitors, mitigating management products are already demonstrating strong growth. against loss of market share. Despite the rapid increase in volume, we expect margin to decline Leveraging digital capabilities to better serve SME segment with the entry of competitors, which may offer up to 50% lower fees unlocks key growth opportunities in most markets as compared with incumbents. In markets such as mainland China, where we expect volume growth to mitigate the fall in fees, digital SMEs in Asia are seeking more funding to drive growth but may not leaders can gain up to ~0.15% ROE uplift, we estimate. In Singapore,
MORGAN STANLEY RESEARCH 19 MM and smaller population markets, we expect fee rate compression to Loan-related fees will see lower compression on unit fees as com- be greater than the increase in volume from digitalisation, with up to pared with other fees. In markets such as Singapore and Hong Kong, ~0.15% ROE fall in the average case, we estimate. As a relatively lower liability spreads in low rate environments should lead to lower underpenetrated wealth management market, revenues should nev- pressure on loan-related fees. In developing markets, such as ertheless grow for Singapore banks due to natural market growth Thailand, growth in loan volume is still likely to be accompanied by and the development of a private banking business catering to a fee compression, as customers move to lower-cost channels, leading wider regional client base. to an average 0.1% ROE fall, we estimate.
B. Fee Unit Impact C. Market Share Impact
Downward pressure on fee unit for various services is likely, as Incumbent banks are likely to lose market share to new digital a result of competition from digital challengers, with greater challengers targeting specific business lines if they stay put pressure on more developed markets Digital challengers are typically intensely customer-focused and With digital challengers having a much lower customer acquisition operate with agility, providing faster time to market and a richer cus- cost, at US$1-38 vs incumbent banks' US$200, digital challengers are tomer experience. These firms provide everyday services at high able to either waive or reduce fees on the services that they offer. In quality and low cost, while offering a smaller range of products as addition, new challengers are not bound by legacy systems and enjoy compared with incumbents. This makes simpler products, such as a leaner cost structure with estimated US$25-63 operating costs, as unsecured loans, more vulnerable to attack by digital challengers as compared with incumbent banks at over US$210. compared to more sophisticated products, such as mortgages. Looking at SME loans, we expect up to 25% of market share could be Larger pressure can be observed in more developed markets. These at stake for working capital loans as compared to up to 15% of market tend to attract a higher concentration of digital challengers that share at stake for investment loans. must directly challenge incumbents to capture market share, resulting in intense competition on fees. In developing markets, fee Higher degree of market share is at stake in markets with favour- reductions should be more moderate, as competitors have the able regulatory environment option to target unbanked customer segments. A supportive regulatory landscape drives more growth for greenfield Wealth management and cards-related fees are likely to see digital challengers, generating more intense competition and higher pressure as compared to loan-related fees in most mar- options for customers. However, specific impacts vary from market kets to market. We expect a higher degree of competition and market share at stake in markets with a favourable regulatory environment, Wealth management businesses could see fee unit compression of such as Hong Kong, where digital challengers are likely to take up to 20% for a significant proportion of products, we believe. market share from incumbents. In Singapore, two out of five licenses Despite the rapid increase in volume, margin is likely to decline with granted allow digital banks to take deposits and provide banking ser- the entrance of competitors, which may offer up to 50% lower fees vices to the retail segment, with a reduced focus on challenging as compared with incumbents. incumbent banks.
Similarly, payments and card-related fees should see pressure on the 3.2 Cost Efficiency merchant discount rate (MDR), the primary source of revenue for payment providers, across markets, due to increased competition. Reducing physical branch footprints, automating processes and MDR may fall faster when regulators intervene with direct measures using advanced technology stacks have the potential to bring to lower the cost of payments, as seen in the case of Malaysia significant cost savings in the longer term imposing a cap on credit card and debit card interchange fees in 2015. The overall impact on payments revenue varies across markets, with Bank branch density should decrease as banks go increasingly digital. digital leaders potentially gaining up to 0.15% ROE, we estimate, in a This effect gradually reduces the number of staff required in scenario in which a few winners take large shares of the market. branches and improves staff cost efficiency. Occupancy costs will
20 MM decline as banks start to reduce their physical footprints, such as Use of lower-cost, cloud-based, scalable technology should fur- branches and ATMs. ther bring cost savings and generate greater productivity in the long term l In Thailand, where physical banking infrastructure is relatively pervasive, we expect a moderate cost saving on occupancy (up to Traditional incumbent banks struggle with fragmentation of IT sys- +0.1% ROE) as banks go more digital by 2025. tems, generating integration complexity and higher costs, duplica- l In Hong Kong, where banks are experiencing an accelerated shift tion of applications and inflated maintenance costs. Up to ~70-80% to digital due to the entrance of licensed digital challengers and of IT spending is committed to maintenance, with only ~20-30% associated regulatory initiatives, we expect ~15% occupancy cost committed to upgrading systems (Source: Oliver Wyman analysis). savings (up to +0.05% ROE) by 2025. While IT system modernisation can be lengthy and costly at first, We note that it will take some time for banks to implement this. Many Asian banks have seen improvements in terms of their productivity banks also still perceive the need for physical presence and are reluc- and have gained cost savings in the long term. We expect up to 10% tant to be a first mover, given market risks. In some markets, regula- reduction in IT costs, driven by developed markets, such as tors also contribute to the reluctance of seeing branch networks fall. Singapore, whilst being lower for developing markets, such as Banks may therefore rethink their branch strategy rather than lower Thailand at 5%, owing to lower projected maintenance costs earned absolute footprint locations. This may result in smaller, optimised by digital leaders. In addition, system rationalisation will bring cas- branches that offer specific services catering to local or regulatory cading positive impacts to operations, improving bank efficiency and needs, such as face-to-face customer onboarding and identity verifi- agility. cation 3.3 Resilience The introduction of banking process automation is rapidly maturing, with many solution providers providing more specialised tailored Cyber risk has significantly increased in recent years, forcing solutions. Processes that involve bulk, repetitive, rules-based proce- banks to enhance their resilience strategies and capabilities. dures are prime candidates for robotic process automation (RPA). Investments are required in the near term for resilience benefits in RPA drives up capacity and allows employees to instead spend more the long term. time on more value-added work. It also brings about up to a 50% increase in productivity, we estimate, while providing 24/7 avail- Many Asian banks face increasing frequency of cyber-attacks and ability and ensuring that processes are regulatory compliant. have responded accordingly with heightened cyber security mea- sures. With a greater move towards digital platforms, Asian banks are Leading Asian banks are accelerating their efforts to implement auto- likely to spend greater percentages of their IT spending on cyberse- mation technologies. The digitalisation impact on cost savings curity. Leading global banks spend up to US$600mn annually on should be significant. Banks in more developed markets tend to be cybersecurity (Source: JPM letter to shareholders 2018). Overall, leading in this space. spending on cybersecurity, including security hardware, services and software in Asia Pacific reached US$16.4bn (Source: International Increases in ROE from staff cost reduction, however, is often subject Data Corporation (IDC)) in 2019, an increase of 20% over the pre- to local regulatory pressures. In contrast, a digital challenger, such as vious year. KakaoBank in Korea, which is free from the burden of branch costs, should have 13% ROE in 2024, we estimate, much higher than our Across the eight Asian markets, we expect cybersecurity costs to projected ~8% ROE, on average, for incumbent Korea banks. In mar- increase by up to 12.5% in 2025. Whilst the overall ROE impact of this kets with relatively high cost-to-income ratios and no prevailing regu- may not be too significant, banks that are not able to build a robust lations, such as Indonesia, where digitalisation of the banking cybersecurity framework are likely to face higher risk of breaches industry is still emerging, we expect staff costs to fall ~10% in 2025, that can bring significant negative impacts to both their business resulting in an incremental ~0.5% ROE gain. operations and customer trust.
MORGAN STANLEY RESEARCH 21 MM Credit costs should increase as a result of increasing credit risks Section 4: Build back better – rethinking associated with lending to the unbanked and underbanked cus- tomer segments. However, digital bank leaders will be those digitalisation that prove better at controlling incremental costs through the use of alternative data sources and intelligent assessment tech- Capturing opportunities and establishing digital leadership niques to assess customer credit risks. In response to fundamental behavioural changes of both customers Through digital channels, banks in developing Asian markets can and employees, the impact of the pandemic has pushed digitalisation drive greater financial inclusion. With better use of data sources to the top of many Asian banks’ agendas. The gap between digital (such as transaction data, inventory data, and invoices), banks can leaders and slow adopters in some markets could be as high as ~5% potentially better assess credit risks of lower-income households by 2025, we estimate. Even the digital leaders of today are not guar- and small enterprises. anteed market-leading positions by 2025, with multiple areas at risk from evolving client expectations, regulatory-driven change, and Despite these new techniques improving the accuracy of credit new market entrants. assessment, the credit risk of previously underbanked customers will still likely be higher than that of traditional banked customers. We have distilled the opportunity into ten key actions that we believe However, digital leaders would be able to minimise incremental banks must address as they reprioritise their digital transformation credit cost by leveraging multiple data sources. Slow adopter banks portfolio for the “new normal” ( Exhibit 20 ). could see 20-25% increases in credit risk costs, while digital leaders will likely see a less-than-proportionate increase in credit cost, owing to better management of risks, ain our view. Generally, we expect to see ~0.1% ROE drag as a result of incremental credit costs.
Exhibit 20: 10 key actions under the “new normal”
Source: Oliver Wyman.
22 MM Action 1: Launch a digital business model, and con- when physical branch visits were not possible. The new initiative was sider adjacent models and propositions to create a success, boosting account opening rates, despite the pandemic. new revenue sources Action 3: Launch new digital products and services to Pre COVID-19, many financial institutions were considering green- adapt to evolving customer needs field ventures on modern, scalable technology stacks, to reduce costs and defend against the growing number of non-traditional new In response to evolving customer needs post-pandemic, incumbent market entrants. Post COVID-19, several new business models will banks need to identify emerging needs then adapt and tailor their likely emerge. Financial institutions need to assess which business offerings. We expect the shift between digital leaders and slow models can help drive sustained success. Key steps for Action 1 adopters in this area to widen as leaders capture market share by tar- include: geting previously underserved customers. Key steps for Action 3 include: l Analyse trends to spot where customer needs and accompanying revenue pools are shifting and where corporate strategic bets l Identify customer segments with accompanying revenue pools need to be placed. and emerging customer needs. l Explore adjacent and emerging digital business models for gener- l Promote use of non-traditional data, such as social media, inven- ating non-traditional, sustainable revenues. tory level and logistics to access customers’ credit ratings. l Incubate new business models and propositions in-market at a l Design products that can be dynamically configured to market low cost by leveraging highly scalable and modern technology changes and varying post-pandemic sector recovery scenarios. platforms. A major bank in Hong Kong designed a trade finance solution for A small number of Asia’s leading banks have taken steps to create e-commerce SMEs. It analyses comprehensive information, including white-labelled services to extend their offerings via banking-as-a-ser- customer background, logistics and inventory data and operation vice ventures. By building application programming interface (API) status, to assess credit worthiness for the targeted SME profiles. driven, partner-ready infrastructure, ecosystem players such as social media, ride-hailing and e-commerce companies are able to provide or Action 4: Accelerate partnerships with ecosystems resell financial service products. and marketplaces
Action 2: Enhance interactive digital channels to Banks traditionally faced challenges in identifying ecosystem part- manage complex transactions ners operating at a similar pace, creating comprehensive data-sharing mechanisms, ensuring optimal ecosystem maturity, and building cus- Post COVID-19, branches will remain relevant for value-added ser- tomisable products that integrate. As supply chains face disruptions vices. As many services move online, we expect branch network from COVID-19, digital ecosystems have shown resilience. Banks expansion to slow and even downsize. As customer expectations for now have a chance to double down on their ecosystem partnerships digital products and interaction have grown significantly, banks will and rapidly adjust to continue serving customers. Key steps for face greater pressure to enhance their digital capabilities to support Action 4 include: new ways of banking. Key steps for Action 2 include: l Identify ecosystems that have expanding customer bases and l Invest in building an intuitive user interface to improve customer address critical customer needs. user experience. l Explore the additional benefits beyond revenue gains when part- l Streamline digital processes by reducing time and steps to com- nering with ecosystems, such as access to non-traditional data or plete banking actions. improved customer experience. l Promote customer engagement through digital channels and l Leverage external APIs and more modular architecture, enabling retain customer connections. agility to quickly respond to changing market demands.
A large bank in India achieved higher virtual customer engagement by A major Thai bank created a healthcare ecosystem, by partnering with launching e-KYC (know your customer) over video to enable contact- hospitals and launching video medical consultations from within less onboarding from home during the COVID-19 lockdown period, their app. The app upsells a bespoke COVID-19 insurance, offering fur-
MORGAN STANLEY RESEARCH 23 MM ther value to the bank and end-customers. 840,000 insurance poli- computing, AI, big data, and blockchains, allowing for significant cies were issued in the first eight weeks of launch. operational efficiency and agility. A Chinese digital bank recently reported handling up to 300mn transactions on a daily basis at an Action 5: Accelerate end-to-end digitalisation via operational cost of just US$0.6 per account per year. automation, artificial intelligence (AI) and workflow Action 7: Shift to a digital and remote working model Around-the-clock availability, organisation-wide consistency, fast response times and zero human error – these are the standards to During the pandemic, some banks have seen a 30-40% increase in which customers have become increasingly accustomed. Through workforce productivity gains - revealing an opportunity for the end-to-end digitalisation, we believe digitally leading banks will be future. Banks should now revisit their human capital strategy, able to meet these expectations. We expect digital leaders to gain realigning everyday work routines to their “new normal” business operational cost savings of up to ~12%. Banks must now double- and operating models, and redefining roles and how tasks are accom- down on efforts to automate processes and expedite decision- plished. Key steps for Action 7 include: making across the organisation. Key steps for Action 5 include: l Redefine workplace policies and arrangements to maintain readi- l Review end-to-end processes across the value chain, identify bot- ness for a remote working model. tlenecks and prioritise improvement areas. l Upskill employees to excel in the new working model. l Re-engineer data models and process by leveraging automation l Decentralise decisionmaking and adopt formal governance to and AI workflow to overcome operational bottlenecks. complement working model. l Leverage APIs and build modular architecture to connect to external data/service providers and interface with client manage- A large Australian bank deployed secure remote access to its staff, ment tools. numbering 32,000, during the lockdown. The work-from-home expe- rience changed employees’ working preferences. 45% of surveyed A large ASEAN bank was able to reduce the amount of time to re-price staff reported that their productivity increased. 80% of staff working home loans from 45 minutes to just one minute by using AI and RPA. from home during COVID-19 indicated a preference to continue the flexibility to work remotely in the future (Source: Oliver Wyman anal- Action 6: Create a low-cost, digital, scalable and ysis). robust architecture Action 8: Institutionalise organisational agility and Pressure to limit technical debt from legacy systems and intensifying speed competition from digital challengers is increasing the urgency to address limitations in core infrastructure. It is increasingly important The responsiveness to an unpredictable market event will become a for banks to focus their efforts on building a digital foundational new KPI that businesses will plan and train for. Banks have been able architecture. While IT spending could increase when upgrading the to issue new products, services and communications to customers at system and back-end architecture, we expect significant cost savings varying speeds. Those that continue to act quickly will emerge suc- to be reaped in the long term. Key steps for Action 6 include: cessful in a post-COVID-19 world. Key steps for Action 8 include: l Transform into a cloud-native organisation and employ software- l Adopt the rapid minimum viable lovable products (MVLP) launch as-a-service (SaaS) where possible. approach to move launch timelines from six months to just a few l Adopt microservice-based architecture and containerisation of weeks. service as standard. l Build lean governance and empower teams with decentralised l Incubate open API program to lay foundations for ecosystem decision-making capabilities to boost efficiency. development partners. An ASEAN ride-hailing provider was able to introduce multiple insur- Greenfield digital banks build a highly scalable, low-cost, and cloud- ance products through its app within a few weeks of partnering with based architecture, utilising cutting-edge technologies such as cloud a global property and casualty insurance firm.
24 MM Action 9: Embed data-led digital decision-making at Action 10: Review and invest in upgrading data and all levels of the organisation cybersecurity controls
Decision-making around credit and operational risks should be Threats to cybersecurity continue to increase, and banks need to data-led and accelerated to cope with varying customer needs. build resilience to maintain customer trust and security. Institutions Integration with alternative data sources, facilitated by a flexible should evaluate control mechanisms by thinking about future states. technology architecture, will further enhance processes and deci- Once the delta between the current and future state has been under- sion-making. Key steps for Action 9 include: stood, new and improved controls can be defined and implemented. Key steps for Action 10 include: l Transform the decision-making process from being data-driven to being data-led to proactively make business and organisation l Design comprehensive cybersecurity metrics for senior manage- decisions. ment and incorporate those metrics in the decision-making pro- l Prioritise the development of automated credit models by using cess. alternative data sources. l Redesign cyber risk resilience operating models in response to l Adopt new AI/machine learning (ML) technology architecture to widening attack surfaces and threat vectors arising due to digitali- automate and assist in the decision-making process. sation and remote access. l Redefine roles for humans in new processes, such as monitoring l Review risks associated with third parties, set up security and results, patterns and optimising algorithms to improve overall access controls, and monitor data shared. efficiency or maintaining ethical use of data. l Manage human communications to drive resilience, awareness and cyber discipline. Multiple fintech providers have recently gained rapid traction with Asian banks seeking to mine public social media, for digitally-driven Over 50% of Hong Kong residents aged 18-55 have encountered cyber prospecting decisions. Digital insights are enabling banks to micro- scams directly via banking channels. The increased use of digital has segment customers and market to them in more relevant, targeted caused the Hong Kong banking sector to launch educational cam- ways. paigns to customers and employees on the importance of safe internet practices.
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