Big bank theory

It is a book that Piyush Gupta, group CEO of DBS Group Holdings D05

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DBS GROUP HOLDINGS LTD

BANKING & INVESTMENT SERVICES

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, has just finished reading. “All the central banks in the world get together and decide to support a global coin and a global framework,” says Gupta in an interview with The Edge Singapore on the topic of decentralised finance (DeFi) and its impact on the future of banking. (See also: Lessons from DeFi, P2P and the future that didn’t work)

In the novel, the ministry achieved a good outcome for Planet Earth by creating a single global coin based on carbon credits and blockchain solutions. While these concepts already exist individually, they have not yet come together in the way described by the author Kim Stanley Robinson.

“It’s okay in fiction but I just don’t see that happening in the foreseeable future, in the next 10 years,” Gupta muses.

DeFi is based on secured distributed ledger technology, of which blockchain is a subset and from which cryptocurrencies are created. The goal of DeFi is to challenge the use of centralised financial institutions and third parties involved in financial transactions, such as central banks and commercial banks.

See also: Citi, HSBC eye mass affluent in S’pore with branch pivots, new offerings

“The basic notion of decentralised finance is that you don’t need any central bank because everybody can deal with everybody. If you really take the concept of DeFi to its fundamentals, it argues for nine billion self-sovereign individuals dealing with each other as global citizens, using a common currency to become part of a global citizen framework. I am not sure the world is ready for that,” Gupta says.

Promising profits

Is Gupta speaking too soon? When he became CEO of DBS in 2009, DeFi, distributed ledger, blockchain and fintech were still the future. A year later, DBS made an impairment of $1 billion against its $10 billion investment in Dao Heng Bank, now DBS Hong Kong. The one-off charge brought DBS’s net profit for FY2010 ended December 2010 down to $1.6 billion that year. This is less than the $2 billion DBS recorded in FY2009 when the Global Financial Crisis was in full swing.

See also: HSBC repays 24-year-old legacy capital in balance sheet cleanup

Compare those challenging years to DBS’s latest half-year financials. In 1HFY2023 ended June, DBS Hong Kong announced a net profit of $808 million, up 36% y-o-y. Group net profit stood at $5.26 billion. Mathematically, if nothing drastic materialises in the second half, DBS will meet its $10 billion net profit target when it reports next February. (See also: DBS offers better risk-reward with NIM and dividend)

How did DBS get from there to here? “I’ve never had a vision around a profit target,” Gupta claims. “But if you look at our track record over this decade, we’ve been able to deliver high single-digit top line growth and double-digit bottom line growth. With the capabilities we’ve built and the macro environment, I think that we’re still in a position to be able to do that in the remaining part of the decade.”

As he tells it, DBS will “continue to be powered by doubling down on some of the businesses that have helped us in the previous decade”. These are likely to be its wealth management business, transaction banking franchise and treasury markets business.

Transaction banking is a core business for banks. It provides access to business and consumer transaction accounts. Initially a proprietary trading venture, treasury markets now serve customers. Amid rising interest rates, businesses are forced to hedge their positions to manage debt costs and foreign exchange.

Geographically, DBS plans to remain Asia-centric. It aims to focus on the big markets in Asia, India, China, Indonesia and Taiwan. “Our market shares in these markets are relatively low. So there is enough headroom within that to grow. In particular, we will now build a comprehensive platform in India and Taiwan,” Gupta says.

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Moreover, these markets are somewhat countercyclical. While DBS had significant growth in the Hong Kong-China axis for much of 2010 to 2015, China is slowing, both demographically and possibly structurally. In contrast, India — where DBS acquired Lakshmi Vilas Bank — is viewed as Asia’s new growth engine.

Meanwhile, within Asean and its Singapore hub, the China-plus-one strategy continues apace as banks scramble to grab a portion of the trade, investment, and wealth flows from China and elsewhere in Asia and globally.

Credit and risk

One of the big differences in DBS today, compared to 10 years ago, is risk management and its ability to manage credit. This is accomplished with the help of digital technologies — especially through the use of AI, data analytics and predictive tools across the bank.

DBS’s organisational structure is now horizontal instead of vertical as part of the change. “We call it managing through journeys,” Gupta adds. “We use controlled trials and data-driven operating models. We have built the muscle for experimentation and A/B testing. As we take things to market, we are heavily AI-driven in all the products that we create. We are increasingly using workflow engines, so work flows horizontally but remains completely transparent.”

On credit risk management, Gupta says the bank has been “conservative” in this challenging environment. “If you look at our allowance coverage, we are at 127%. We are at a different starting position this quarter. We have built up huge allowances over the last three years and we’ve taken them through the P&L,” he points out.

As at June, DBS’s total general provisioning was $3.8 billion, with specific provisions at $2.5 billion. For its peers, analysts have indicated that if the regulatory loss allowance reserve (RLAR) is included, the coverage is around 100%. RLAR is a non-distributable additional loss allowance account appropriated through retained earnings. Banks are required to set aside a minimum loss allowance of 1% on exposures with the excess to be recorded as capital. RLAR can be used to cushion higher credit losses that occur during economic downturns.

“If you look at our Pillar 3 disclosures, the probability of default for our portfolio has improved from 1.6% to 1.2% over the last few quarters. That can only happen if your underlying portfolio is improving,” Gupta explains.

Case in point, DBS’s watch-list names are coming down while non-performing loans (NPL) fell to 1.1% in 2022 from 1.3% in 2021.

The lower numbers reflect better credit management and the use of data and AI in models for onboarding new customers and underwriting. These models have also served as early warning signals. “We are able to get a much better forward-looking view of where we think problems might be coming,” Gupta says.

Technology as an enabler

In 2016, DBS was the first local bank to launch its digital bank, named DBS digibank, in India. Since then, the Monetary Authority of Singapore has given licences for two digital full banks — GXS Bank and MariBank, which were launched last year and this year respectively. Standard Chartered Bank and Fairprice Group together set up Trust Bank.

“Even assuming the digital banks get traction, it could take them forever to gain any material and meaningful market share,” Gupta says. Indeed, over the past 10 years, several digital or neobanks have mushroomed in the UK. The better-known names include Starling Bank, Monzo, Revolut, Atome Bank and N26 but their collective market share remains extremely modest.

“In terms of capabilities, I think we can compete with anybody. In the short term, people will compete on price. None of this is a structurally big threat to the banking sector,” Gupta adds.

In addition to AI and data analytics, DBS is looking for “incremental revenue streams” using partnerships and ecosystems to originate new businesses. DBS has its digital exchange, DDEX. “Our digital capabilities, even in our core businesses, give us the opportunity to democratise wealth using digital channels,” Gupta claims.

Although the global cryptocurrency winter shows scant signs of thawing, Gupta believes that trading tokens and other digital assets will likely rebound. “The investments and efforts we put into digital banking will bear fruit for some time to come,” he says.

DBS is looking at ways to harness generative AI. On the revenue front, generative AI could help dish out investment advice. In 2013, DBS worked with IBM’s Watson, a supercomputing platform, to generate customised advice for clients. The two companies are no strangers to each other. In 2002, DBS famously outsourced the bulk of its IT functions to the American company in a 10-year deal worth $1.2 billion. “We were a guinea pig for Watson. That didn’t work because AI was not well developed enough,” Gupta acknowledges. More recently, DBS has been using rudimentary AI at a portfolio level for its digibank portfolios.

AI could help to change a bank’s cost structures, says Gupta. DBS’s cost-to-income ratio of 38% in 2QFY2023 is the lowest among the local banks although he wonders if generative AI can develop a business model with an even lower cost. A low-cost business model enables a bank to price its products differently.

On the wealth front, DBS was fourth in the regional league table after Credit Suisse. With the merger of UBS and Credit Suisse, Gupta figures DBS could be third even as wealth creation in Asia continues to grow.

“If you have a good platform and the right set of capabilities, you can still grow market share. We have a fantastic digital platform. We’re using more and more AI to advise our clients. We bring corporate investment banking capabilities along with private banking capabilities for the tycoons. Because we have a single platform, we run a very efficient shop. We are the most profitable and have the lowest cost in the industry,” Gupta says.

Higher profits, higher dividends

Higher earnings usually lead to higher dividends for banks as the baseline dividend payout ratios are around 50% for all three local banks. This enables banks to retain 50% of their earnings for capital and growth investment.

Starting next year, new Basel rules — known as Basel IV — will kick in, with a transition period of four years. “There are marginal changes in the treatment of individual portfolios but none of those changes warrant us having to change our strategy,” Gupta says.

During the transition period, DBS’s CET1 (common equity tier 1) rises from 14.1% as at June 30 to 16% and above. “We’ve given guidance to the market that we’re sitting on $3 billion of surplus capital that we plan to return to shareholders over the next couple of years,” he says.

From 2010 to 2023, DBS has been “sensible” about acquisitions. There were sporadic buys or so-called “bolt-on acquisitions” to help drive specific growth but no more grand market-breaking acquisitions in the multi-billion range similar to Dao Heng.

In 2014, DBS bought Societe Generale’s Asian private banking business. In 2018, DBS bought ANZ’s retail banking business in Indonesia and Taiwan, gaining 370,000 customers and 520,000 customers respectively.

In 2021, DBS acquired a 13% stake in Shenzhen Rural Commercial Bank for $1.1 billion and as directed by the Indian government, it also bought Lakshmi Vilas Bank in late 2020. Gupta says the Indian bank is now profitable. Most recently, DBS acquired the retail business of Citigroup Taiwan. “We now know how to be strategic and disciplined about adding on organically to what we have,” Gupta says. “We don’t believe in mega deals,” he says.

“Our focus has been on extracting value from the integration. My worry is if we do something really big, it would be really hard to extract value,” Gupta says. The deal size DBS is comfortable with will likely be $1 billion to $2 billion. This rules out Standard Chartered Bank, which shares the single-largest shareholder as DBS, Temasek Holdings. The UK-headquartered bank has a market value of around two-fifths that of DBS’s $88 billion.

DBS is dedicated to a sustainable future for its customers’ transition to a low-carbon world. In the 2020 book The Ministry for the Future, fictional ministry head Mary Murphy works to convince central banks of climate change’s currency and market stability risks. DBS has committed to a net-zero level of greenhouse gas emissions by 2050. Hopefully, it will not be too late to arrest climate change by that time. Otherwise, Earth’s outcome won’t be as happy as the book’s.

At a personal level, Gupta has been charting a more sustainable path in his 14 years of holding this job than his few immediate predecessors. When asked the secret to his longevity, he answered with a laugh that it was a “low bar” to pass. Before his tenure, which began in 2009, none of Gupta’s five predecessors were in the role for more than five years.

On a more serious note, the ever-changing nature of the job is one that Gupta enjoys about his role. “The industry has been changing; the market has been changing, digitalisation, sustainability and AI … There is just so much happening that it gives you the possibility and chance to reinvent yourself while you’re reinventing the company. And we’ve completely pivoted this company in terms of culture, internal way of working, you know, and so on; so, that gives you a longer lease of life,” he says.

For him, the second reason, which is more germane, is that most CEOs stay at the whims of the board and, ultimately, the shareholders. “The only way you can stay for a long time is that you continue to produce performance. If you don’t produce performance, then sooner or later shareholders get tired [and ask for someone else]. We’ve been fortunate that our track record has been very consistent.”