MAS report finds Hong Kong

MAS report finds Hong Kong, Korea and Singapore banks vulnerable to FinTech disruption due to reliance on payment fees

In its recent Financial
Stability Review (FSR) report
, the Macroprudential Surveillance Department
of the Monetary Authority of Singapore (MAS) assessed the extent to which
FinTech companies could disintermediate Asian banks and erode their operating
income over the next five years.  MAS’
analysis finds that the FinTech challenge is generally more significant in the
payments than in the deposit and lending business. This is especially so for
banks in Hong Kong, Korea and Singapore, in view of their greater reliance on
payment fee income.

The report notes that FinTech
presents opportunities for banks to improve their profitability from both the
cost and revenue angles, whether exploited either internally within banks or
through collaborative partnerships with FinTech companies.

Analysis from McKinsey is quoted, saying that cost savings
from leveraging on FinTech, for instance via automation of banking functions or
the use of artificial intelligence, could yield a 30% reduction in costs, representing
10% to 20% of Asian banks’ operating income.

FinTech can also facilitates potential revenue growth for
banks, for instance through reaching out to new customers via mobile services,
especially in countries with relatively lower financial inclusion. The report
cites the example of DBS Digibank in India and Indonesia. The move towards
cashless payments could also benefit banks, if such digital payment platforms
are linked to bank-issued cards.

Increased revenues from innovative new offers and business
models could increase banks’ net profits by 5%. Furthermore, new products,
distinctive digital sales and using data to cross-sell products could increase
banks’ net profits by a further 10%.

FinTech companies are beginning to offer services that
disintermediate banking services. The competitive threat and its corresponding
impact is expected to vary across business lines. Analysts have highlighted
that there is relatively more FinTech investment in retail and consumer banking,
especially in the areas of deposit-taking, lending and payments. This view was
corroborated by MAS’ discussions with banks that operate in Asia. The MAS study
therefore focuses on the impact of FinTech on banks’ operating income in these

Potential reduction
in fee income and net interest income

The study estimated the potential reduction in banks’
payment fee income and net interest income owing to disintermediation by
FinTech companies. The analysis is based on a downside scenario where banks
fail to take mitigating actions to address the competition.

Fee income

Firstly, FinTech companies could offer payment options that
compete directly with debit and credit cards issued by banks. This may erode
banks’ fee income through lower payment transaction volumes as consumers switch
to FinTech payment channels; and lower fees as banks reduce the Merchant
Discount Rate (MDR) that they charge for card payments in response to more
competitive transaction fees offered by FinTech companies.

Using third-party information, MAS assessed the probability
of payments disintermediation based on: 1) Pre-existing scale of FinTech
adoption; 2) Conduciveness for FinTech to develop in terms of the regulatory
environment, extent of government support and proximity to relevant expertise; 3)
Customer readiness, based on forecasted internet and mobile penetration rates
in five years.

Based on these factors, each economy is assigned a rating based on a scale of 1–5, with 1 and 5 representing a low and high probability respectively of payments disintermediation within the next five years. Each rating is then mapped to a projected FinTech payments adoption rate, expressed as a proportion of Household Consumption Expenditure (HCE).

MAS summed up the reduction in operating income from both lower payment transaction volume and margin erosion. The report cautions that the estimated losses would probably be overstated as there would likely be some offsetting effects.

Above image: Estimated Potential Reduction in Operating Income from
Disintermediation in Payments Business/ Credit: MAS (Source: MAS estimates, CEIC, Central Banks, iResearch, SNL Financial)

Net interest income

MAS also considered the impact of FinTech on net interest
income from deposit and lending business. FinTech enables pure play digital
banks to be set up at lower cost than traditional banks, which could enable
these new players to offer more attractive deposit rates. This poses a threat
to incumbent banks by eroding their deposit funding base and increasing banks’
funding costs as they would need to either raise deposit rates to retain
deposits or seek more costly funding in the interbank market. This would erode
banks’ interest margins.

Alternatively, banks may reduce lending volumes if they are
unable to secure adequate funding. Either strategy would result in lower net
interest income.

MAS estimated the potential loss of deposit funding using
third-party information on the share of the banked population that is prepared
to switch to pure play digital banks and the proportion of deposits that they
would be willing to move to such banks. MAS then derived the potential increase
in funding costs (and the resulting fall in net interest income) if the banks
try to fill the funding gap by borrowing from the interbank market or by
raising deposit rates to the interbank rate.

Alternatively, assuming that banks choose to reduce lending
to maintain their Loan-to-Deposit (LTD) ratios, MAS estimated the drop in net
interest income as a result of lower business activity.

The chart below from the report illustrates the impact of
disintermediation on banks’ net interest income. MAS assumed that banks would
take the option that would lead to a smaller drop in operating income. For
example, banks in Singapore would likely increase their deposit rates and/ or
seek interbank funding as opposed to reducing their loan volumes.

Above image: Estimated Potential Reduction in Operating
Income from Disintermediation
in Deposit and Lending Business/ Credit: MAS (Source: MAS estimates, Bloomberg, CEIC, Central Banks,
SNL Financial, World Bank)

The chart at the top of the article aggregates
the estimated impact of FinTech-driven disintermediation on banks’ payments,
deposit-taking and lending businesses. With the exception of Chinese banks,
banks in Asia would generally face larger potential reductions in operating
income from their payments business, relative to their deposit and lending business.
This is especially so for banks in developed Asia due to their greater reliance
on payment fee income.

As mentioned earlier, the report says that estimated
potential reduction in operating income is based on an unmitigated scenario in
which banks do not take actions to address the FinTech competition. Banks that
harness technology could perform better compared to those that do not. The pace
of a bank’s digitalisation would depend on factors such as its ability, such as
its resources, knowledge, and availability of talent) and openness to adopting
technology. The impact of FinTech on banks could be further differentiated
depending on other bank-specific factors. For example, larger banks have
broader customer bases that could make them more attractive to talent or to
FinTech companies for partnership opportunities. However, the report also cautions
that larger banks could be bogged down with large legacy systems, making them less
nimble in their digitalisation journey.

As more data becomes available, the study could be expanded
to include other business lines, such as wealth management, insurance and
remittance. The analysis can also be extended to assess potential second-round
effects from FinTech disruption. For instance, disintermediation would reduce
transaction flows and the amount of customer data that banks could collect
about their clients. With fewer insights on their customers, banks would have
fewer cross-selling opportunities and their risk assessments may become less