SEA banks well positioned against fintech disruptors after successful digital transformation, Moody’s says

by James · March 2, 2023

Banks in Southeast Asia have made significant progress on their digital transformation journey, and incumbents willing to invest in technology are well positioned to compete with fintech, Moody’s said on Thursday.

The rating agency said in a note that Southeast Asian banks have invested significantly in digital transformation to compete with fintech disruptors.

It said the result has been progress on several fronts: widespread customer adoption of its digital channels and improved product quality.

“The competitive landscape for digital financial products will continue to evolve, but Southeast Asian banks are well positioned to compete, given their track record in recent years, and more so for large banks with the scale to make the necessary investments,” Moody’s said.

According to Moody’s, the banks have succeeded in transferring their customers to digital channels.

It noted that customer transactions at the region’s leading banks are now largely processed via the internet and mobile channels.

It is noted that not only in the payments space where there has been a sharp increase in digital adoption, new customer acquisition across retail and small and medium-sized enterprise (SME) products is also increasingly done online.

It said most banks now offer a comprehensive suite of banking products digitally, across liabilities and assets, and for both retail and SME customers.

It said banks have also made significant improvements in mobile user interface, closing the gap with fintechs and digital banks.

According to Moody’s, consumer mobile apps for leading banks are rated 4 or higher out of a total score of 5.

It said that high-quality user interfaces are now prevalent among leading incumbents and no longer a competitive advantage for the new entrants.

Furthermore, it said banks have been proactive in working with firms that have a digital footprint, within and outside financial services, and to allow customers of those firms to access financial services through application programming interfaces (APIs).

For example, in Thailand, KBank embedded its financial services into the popular messaging app, Line, while Singapore’s DBS Group Holdings Ltd incorporated Gojek’s ride-messaging service into its digital wallet PayLah! and vice versa.

These integrations create a seamless user experience and expand banks’ online presence, Moody’s said.

According to Moody’s, the banks see digitization as the core of their overall strategy. This is reflected in the significant investments that have been made in recent years, and we expect this trend to continue.

Meanwhile, in most markets in emerging Southeast Asia, the deposit share of leading banks has increased in part due to their stronger digital franchise.

While Southeast Asia has a number of high-profile fintechs and they managed to build large customer bases through digital payments, Moody’s noted that for most countries, their expansion in financial services remains modest.

These firms also remain loss-making and, given tighter financing conditions, will dampen their expansion, Moody’s said.

According to Moody’s, in their respective markets, fintechs were the first to introduce digital payments through e-wallets and Quick Response (QR) codes.

It said before the rollout of national retail payment systems, the fintechs offered faster settlements than through card payments and bank transfers.

For merchants, it said QR code payments carry lower fees than credit card payments.

In addition, it said the new entrants were pioneering “super” apps, which integrate many lifestyle and financial services into a single mobile app.

It said Southeast Asia’s fintechs typically offer financial services as part of a broader product offering, such as e-commerce and transportation services.

It also said that they have now expanded beyond payments to other financial services such as lending and have also entered the banking space.

“Some have secured digital banking licenses and in the case of Indonesian fintech firms, they have bought stakes in existing banks,” Moody’s said.

Moody’s also said the regulatory push for open architecture and the rise of national retail payment systems are reducing fintechs’ first-mover advantage in digital payments, where they have the strongest presence.

Tt said fintech expansion beyond digital payments remains limited.

Lending, which is a central focus, is still small. In particular, the penetration of buy now pay later (BNPL) transactions remains low.

Similarly, it said Sea Limited (Sea), one of Southeast Asia’s largest consumer technology firms, reported net loan receivables of $2.2 billion as of September 30, 2022 – a small amount considering its sprawling operations across Southeast Asia.

Moody’s also noted that fintech is disrupting business models that have yet to be proven, while a challenging funding environment will dampen the pace of expansion.

“As with other start-ups, fintech is still loss-making. The financial services divisions of Grab and Sea, some of the most prominent technology companies in the region, remain loss-making despite years of operations, Moody’s says.

It said that for many fintechs, the payments business alone is not profitable and they have had limited success in cross-selling other financial services.

“We expect their increasing focus on lending to support revenue generation, but they will need to establish a track record in underwriting, as they typically lend to the unbanked and underserved, which are traditionally risky segments,” Moody’s said.

It said a highly favorable financing environment before 2022 allowed these companies to withstand heavy losses while pursuing aggressive growth.

But it noted that the funding environment has since tightened significantly, with fintech funding in Southeast Asia falling sharply in the third quarter of 2022.

It said these developments are forcing tech companies to implement cost-cutting measures and delay initial public offerings, which in turn will curb their expansion.

For example, Grab Holdings Inc has reduced incentives for its drivers and recently implemented wage freezes and budget cuts.

Meanwhile, Moody’s believed that regulations will continue to play an important role in the development of the market structure.

It said regulators seek to encourage financial innovation and do not intend to shield banks from new entrants.

At the same time, it said it seeks to encourage open architecture systems that make it difficult for new entrants to use their captive customer bases to develop closed-loop ecosystems.

To promote innovation, it said regulators have implemented or are in the process of implementing many initiatives to support fintech growth without compromising financial stability.

These include regulatory sandboxes, rules for digital wallets, peer-to-peer (P2P) lending and APIs, as well as licensing frameworks for digital banks.

It also said the new licensing rules for digital banks have led to the proliferation of new entrants across Southeast Asia.

It noted that financial authorities in Singapore, Malaysia and the Philippines have issued new licenses under looser regulatory requirements compared to those for commercial banks, while their Indonesian counterparts have encouraged the acquisition and digitization of existing banks through higher minimum core capital and equal regulatory treatment.

It noted that Thai authorities have also drafted their digital bank licensing rules in January 2023, and they plan to receive applications in the second quarter of 2023.

“All of these initiatives will promote competition and provide a level playing field for new entrants,” Moody’s said.

Moody’s also said regulators are trying to incentivize open architecture systems that make it difficult for new entrants to use their captive customer bases to develop closed-loop ecosystems.

It said the emergence of national retail payment systems across key markets in Southeast Asia is a good example of this.

It said this trend changed the competitive landscape, especially for banks, as the payment services they offer are now settled in real time and cost little or nothing to both consumers and merchants.

It said bank transfers are more convenient now that deposit accounts can be tagged to mobile, personal identification and business registration numbers.

It said regulators have also introduced interoperable QR codes that have been adopted in most countries in the region.

The use of interoperable QR code increases payment efficiency by preventing market fragmentation while also preventing customers from being locked into a particular service provider, it added.

According to Moody’s, the region has also taken a step further by connecting these payment systems with each other under the Association of Southeast Asian Nations Economic Community Blueprint 2025, which in turn will facilitate cheaper, faster cross-border transactions.

It said regulatory initiatives have removed some arbitrage in rules and regulations that worked in favor of fintechs.

For example, banks, which are subject to stricter know-your-customer (KYC) rules, benefited from the introduction of electronic KYC regulations as they were able to offer remote deposit opening.