This article first appeared in The Edge Malaysia Weekly on July 17, 2017 - July 23, 2017

FINTECH will not disrupt banks. Banks will disrupt banks,” Sachin Mittal told delegates at the BankTech Asia 2017 conference earlier this month.

And the banks that come out on top in the fintech revolution will be the stocks to watch out for, he said.

The senior vice-president of group equity research at DBS Bank believes that fintech firms do not pose a big threat to banks, at least for now.

These firms certainly have the cost advantage from better efficiency, offer better user experience and aggregate more data than banks, but they lack the balance sheet and distribution network to do any real damage to conventional banks, he added.

Furthermore, regulators have begun to impose regulatory hurdles on successful fintech firms that aim to supplant the bread-and-butter business of banks.

Rather, Sachin sees banks posing a bigger threat to each other.

How? By adopting best practices and innovations from fintech firms.

“Fintech companies have shown the way — technology can be a big differentiator in winning customers in chosen segments and/or products,” Sachin said.

He pointed out that fintech firms have already shown a strong competitive advantage, based on costs and the fees they are charging.

For example, Alipay’s sales fees to merchants range from 0.7% to 1.2%, compared with the 1.5% to 3.5% currently charged by credit card companies in China. Another example is the 0.15% to 0.35% fees charged by online financial service adviser Betterment. It is substantially lower than the 0.7% to 1% fees typically charged by financial advisers.

One key reason for the lower fees is that fintech firms tend to be substantially more efficient and incur lower costs. This allows them to operate on a lower non-interest income.

Of course, these companies are also more aggressive when it comes to customer acquisition. Most are backed by venture capital funds and are under tremendous pressure to achieve substantial scale where their business model will become sustainable.

However, these advantages can pose limitations to fintech firms as they are prevented from doing too much damage to banks.

One example cited by Sachin is the maximum deposit of RMB1,000 that Chinese regulators imposed on “Type III accounts” — the kind that China’s prominent payment service providers, Alipay and Tencent, had hoped to deploy en masse in an evolution that would have directly challenged conventional banking.

Type III accounts refer to online accounts that are relatively easy to open. As at June last year, there were an estimated 7.8 billion bank accounts in China — nearly 5.7 accounts per individual.

Chinese regulators have had to subject online banks to the same know-your-customer requirement that conventional banks have to adhere to. This requires online banks to verify customers’ identities at physical branches. The move, supposedly to tackle the growing problem of internet and telephone scams, was a huge blow to Alipay and Tencent’s online bank ambitions.

The point is, fintech firms will have to play by the same rules as the banks, even in countries where they have seen unbridled success. Regulators will make sure of that, said Sachin.

This creates a major barrier to enter for fintech firms.

Banks must evolve quickly or risk everything

Sachin pointed out two key ways in which banks can adopt fintech innovations. One, by improving existing products digitally so that they are faster, cheaper and easier to use.

Two, by adopting a customer ecosystem approach that integrates banking into customers’ daily lives.

“Retail banks that are unable to adopt a digital model may see a drop in return on equity by around 18% over five years due to competition from fintech firms and other banks. However, retail banks that are able to reinvent themselves could see a substantial increase in ROE of around 18%,” he said.

In a report last year, Sachin highlighted that the share prices of digital-savvy retail banks could be 50% to 80% higher than those of non-digital banks.

While banking costs have not yet dropped perceptibly in Malaysia to reflect this competition, the improving quality of personal banking apps could be a barometer of a bank’s digital savviness.

It is subjective, but there appears to be a growing divide in the quality of user experience between one banking app and another.

It is also important to note that the number of online banking and mobile banking users has grown tremendously in the past 10 years. Bank Negara Malaysia statistics show that internet banking penetration rose to a whopping 77.6%, or 23.7 million individual users, as at May this year from 16.9% in 2007. The number of mobile banking users also grew more than 10 times in the same period, from less than 2% to 21.9%, or 9.9 million users.

It is worth noting that non-banks still appear to outperform banks when it comes to user experience. Last year’s EY Global Consumer Banking Survey, which involved 55,000 consumers, found that four of the top five reasons customers considered using a non-bank for services were related to customer experience.

It is also interesting to note that the key to providing a better customer experience does not lie in simply hiring more or better customer service staff. Instead, many fintech firms rely on a combination of thoughtfully designed user interface for their apps and websites, along with artificial intelligence chat bots that run on pre-programmed scripts to service customers. The result is a better overall user experience and a relatively low per-customer support cost.

Indeed, Sachin believes banks that adopt some of these cost-saving measures and improve consumer experience will pose a bigger threat to other banks.

He conceded that margins might be lower, but the growth in revenue from customer acquisition would offset that.

He also pointed out that retail banks have the most to lose or gain from the coming wave of fintech innovation as corporate banking remains highly relationship-based and has higher stickiness with clients.

By far, Public Bank Bhd is the local bank that draws the largest proportion of its revenue from consumer and retail banking, and fund management — 68.7%.

On the other end of the spectrum, RHB Bank Bhd draws only 37% of its revenue from these segments.

CIMB Group Holdings Bhd falls somewhere in the middle of the pack with 52.9% of its revenue coming from the said segments, while Malayan Banking Bhd is not far behind Public Bank with 65%.

By sheer size, Public Bank has the largest revenue base from the consumer segments — RM3.46 billion as at the first quarter of this year — followed by Maybank (RM2.76 billion) and CIMB (RM1.4 billion).

It is also important to note that it is not a zero-sum game in the domestic market. Fintech also allows banks to quickly expand their reach in foreign territories in a more nimble manner at relatively low costs.

Sachin’s report points to Spanish lender BBVA, which acquired US-based online direct bank Simple for US$117 million in 2014. With the acquisition, BBVA immediately gained access to over 100,000 US customers. It also acquired a 30% stake in Atom, the first mobile-only bank in the UK, which launched its services early last year, notes the report.

In comparison to BBVA, which has committed to invest €1 billion in the digital initiative between 2013 and 2017, Malaysian banks do not appear to be as aggressive.

At €250 million a year, BBVA is only spending 3% of its annual revenue on such initiatives. Royal Bank of Scotland is likewise investing about 3% of its revenue while retail banks in the US are looking to spend 4% by 2020, notes the report.

Of course, part of the reason could be the slow rate of adoption of fintech among Malaysian consumers — the DBS Bank report estimates that less than 5% of banked users in Malaysia have adopted fintech.

However, “things could reach a tipping point in four to five years, given the high mobile penetration rates and government support”, notes the report, referring specifically to Thai, Malaysian and Indonesian banks.

In turn, investors should watch closely how much Malaysian banks are investing in fintech going forward. Or, more importantly, the banks that fail to do so.

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