The year’s best-performing local bank is DBS Group Holdings, up 25.27% from the start of the year to Dec 13; United Overseas Bank (UOB) is No 2, up 17.5% year to date. Oversea Chinese Banking Corp (OCBC) is up 12.2% this year. The banks’ competitor, Sea, which was awarded a digital full bank (DFB) licence by the Monetary Authority of Singapore (MAS) last year, narrowly beat UOB to notch a gain of 17.8%.

At one point, Sea was up a lot more. At its all-time high, Sea had gained more than 80% but since that fateful day in October — a month that is sometimes the graveyard of a bull market. Sea’s share price is down 35%.

The local banks are a lot less volatile. Since they were allowed to resume their full dividend payouts, their dividend yields are above 4% (see table 1) and the price to net asset value (P/NAV) ratios are fractionally bigger than one. The local banks’ dividend yields are also higher than those of global banks (see table 2).

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The performance of the local banks could be based on their digitalisation initiatives. DBS is perhaps the most far ahead in this area. During DBS’s 3QFY2021 ended September results briefing, group CEO Piyush Gupta announced that the bank had incorporated a company called DBS Finnovation under the banking group this year. DBS’s new activities which involve collaboration and joint ventures with partners for Partior, Climate Impact X and DBS Digital Exchange (DDEX) are held as individual entities under DBS Finnovation.

“The structure will allow us to create partnerships, joint ventures or even our own bespoke activities and keep them at arm’s length from the bank,” Gupta had said during its 3QFY2021 results briefing on Nov 5.

DDEX is a digital exchange where DBS’s capital markets team can originate deals, including fractionalising immovable assets such as property into tokens to list and trade on DDEX. Partior is a joint venture with JP Morgan and Temasek, to enable wholesale cross-border payments. In a pilot, Partior, which uses a form of distributed ledger, was able to undertake an SGD-USD transfer in seconds.

Similarly, UOB’s management has outlined a digital assets strategy. Although UOB group CEO Wee Ee Cheong indicated that he wasn’t convinced of cryptocurrencies being a store of value or legal tender, he says he sees potential in the use of Central Bank Digital Currencies (CBDC).

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“We recognise the benefit of CBDCs which in turn will benefit the overall customer and we are working closely with central banks on this and on asset tokenisation,” Wee says during UOB’s results at end October.

UOB has built strategic alliances with Marketnode and ADDX on the use of DLT to develop the digital capital market infrastructure. UOB’s group CFO Lee Wai Fai says the bank prefers to work with third parties on these new distributed ledger and decentralised finance (DeFi) technologies. “We still believe for banking to be an intermediary there must be some underlying value in there [for the customer]. We know how to structure the products. All we need is an exchange, and we can serve up what the customer wants,” Lee says.

UOB has already piloted its own digital perpetual security on Marketnode and tokenised a Sembcorp Industries sustainability bond on ADDX. “We think CBDCs at some point will be an efficient way to clear the global system,” Lee adds, referring to the huge cross-border payments market.

Web 3.0 and the associate decentralised finance concept is based on disintermediation. “Web 3.0 focuses on issues of trust, transparency, privacy, and user control with a dispersed networks and decentralised consensus, and blockchain technology is at the forefront of this movement,” Fangfang Chen, Asia Pacific chair and Asia Pacific head of asset servicing and digital, BNY Mellon.

”We are seeing technology such as smart contracts and cryptocurrencies highlight financial self-empowerment, with users transacting peer-to-peer (P2P) around the world. Open financial protocols that can be accessed by anyone with an internet connection will create opportunities to revolutionise how individuals interact with financial services,” she explains.

It is interesting that Chen cites P2P transactions as an advantage of DeFi. China experimented with a form of DeFi with P2P lending. Here, an individual borrower can be matched with a corresponding investor (or a few like-minded investors) who is interested in lending to the individual, with an agreed upon interest rate and duration.

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According to a McKinsey report back in 2019, this sort of platform unlocks unlimited potential for individual borrowers to find lenders, at lower rates for the borrowers and at higher interest rates for the lenders as banks and traditional finance companies get “disintermediated”. Since all of this would take place online, many of the transaction costs and inefficiencies associated with traditional financing would be removed and this financial revolution would be led by nimble FinTech startups with new technology and access to funding.

P2P lending was not started in China but it took off in China in 2014 or thereabouts. By 2018, millions of retail investors lost their life savings on P2P lending platforms because of allegations of widespread fraud and mismanagement.

“The whole construct of a decentralised system means you don’t need intermediaries. You could very easily make a case that in a future world, nobody needs banks or stock exchanges anymore. Everybody just deals directly with each other,” Gupta says.

“The P2P lending space in China is a case in point. It had P2P companies trying to intermediate directly between individual savers and corporate and individual borrowers. Then two years ago, the authorities had to shut down many of them because there weren’t enough safety nets. I think over the next 5–10 years rules will have to be built to protect individuals,” adds Gupta.

Wee’s view is that the technology that drives DeFi and blockchain can be used by financial institutions but DeFi itself needs careful design so that his customers are protected from the downsides of P2P lending such as the experience in China.

“What is more important is that we must make sure we protect the user’s interest. The concept is a simpler way of looking at things,” Wee says when asked about his thoughts on Web 3.0 and DeFi. “We are looking to make banking simpler, safer and smarter with the use of AI, DLT and how we can use asset tokenisation working with central banks, to benefit the customers. This is a new idea, a new concept. We just have to make sure it’s very transparent and you have the proper governance framework,” Wee says.

Ready for the competition

With the move into digital assets and the use of AI to make their banking apps more intuitive, the local banks are getting ready for the launch of the new digital full banks (DFB) in 2022. The Grab Holdings-Singapore Telecommunications partnership (which was awarded a DFB in 2020) and Sea have through their current operations attempted to embed themselves into the lives of consumers.

Grab provides ride-hailing, food delivery and other simple financial services such as insurance for Grab driver vehicles. Sea runs the gaming platform Garena and a shopping platform Shopee.

“The two licensees have user bases equivalent to around half of Asean-6 markets’ 580 million population and boast deep-pocketed global tech players like Softbank and Tencent Holdings as key backers,” notes Fitch Ratings.

The two challengers have been able to raise large sums of fresh capital, which gives them greater financial flexibility to grow their financial services units rapidly in the region, Fitch adds. Their Singapore licences could allow them to set up banking operations in up to two overseas markets eventually. Grab/Singtel applied for a digital bank licence in Malaysia in June while Sea acquired Bank Kesejahteraan Ekonomi in Indonesia in February

Challenges for new challenger banks

On the other hand, Fitch cautions that the path to profitability for the new entrants is uncertain. “Attaining profitability for new entrants is often accompanied by capital-intensive business models and digital players with deep customer engagement are more likely to secure recurring business and reach sustained profitability. This has proven to be a high hurdle for the majority of existing digital banks,” Fitch warns.

Of course, Asean is a large market with underserved segments. Already, UOB TMRW, a digital bank, has a presence in Indonesia and Thailand, with plans to launch in Vietnam.

In addition, to attract deposits and disburse loans, the new digital players may have to offer more attractive rates such as higher deposit rates and lower lending rates. But the new DFBs have already been warned off value-destroying competition. “On the revenue side, we expect most digital banks to first focus on the under-served segments, which reduces profitability pressure on incumbent banks in the initial onslaught,” Fitch reckons.

However, assessing the credit risks of the underbanked segments is likely to be difficult with limited credit history in Asean. The uneven development of technological infrastructure in certain locales may also hinder digital banks’ ability to access their target customers.

Regulation could also pressure the new digital banks. “Increased regulatory scrutiny, as seen in China over the past year, for example, could raise compliance hurdles for digital banks and exacerbate execution risks, especially as they become more systemically important. A levelling of prudential requirements would make it more challenging for digital banks to thrive and could reduce competition and profitability pressures for incumbents,” Fitch points out.

Digital banks are individually very unlikely to wrestle more than a few percentage points of market share within the next five years given the size of incumbent banks, it adds. All in, Fitch reckons the impact from competition from the new digital banks “will be modest for the large Fitch-rated banks in southeast Asia in the near term”.

Interestingly, the local banks have already moved up the technology ladder and continue to do so, employing DLT in various aspects of their business such as bond issuance, trade finance and cross-border transfers, and AI for credit scoring, financial behaviour and engagement. By the time the new DFBs open for business in 2022, learnings from their adoption of AI on the consumer front and efficiency on the wholesale sector would have pushed them further ahead.

Being digitally and financially competent are among the reasons why DBS and UOB’s price performances caught up with and overtook Sea this year.

Local banks move up the technology ladder ahead of 2022 competition

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