Asean's new digital banks will be valued like traditional banks, not pure Internet plays: report

Singapore

ASEAN is seeing a new wave of digital banks that may continue for years. While these young startups may start with "optimistic" Internet valuations, they will, over time, converge to valuations that traditional banks are used to, said Citi in a report on Tuesday.

A key difference between a licensed bank and an Internet platform model is that a bank is subject to strict capital and other regulatory requirements. This means banks are not so easily cost-scalable, and aggressive balance sheet growth can be expensive in terms of high cost of fresh common equity, especially if the bank is loss-making in the early years.

Pure platform models in contrast have high, relatively fixed startup costs but are asset-light and enjoy strong operating leverage as revenues grow. For digital banks embedded in an Internet company ecosystem, the scope of services offered by the bank may be confined to those that have to be conducted under the banking licence, as fee products can be driven out of the Internet platform, said the report.

New digital banks will be accorded premiums for higher growth and profitability. But while they may be given Internet valuations early in their journey, capital and regulation factors mean that digital banks will over time be valued like traditional banks, "not pure Internet plays", said Citi.

Analysts will likely use multi-stage valuation models to value loss-making or low-profit startups, but valuations will be "swayed by large terminal values and carry considerable risk".

"To justify high target prices, a large part of the calculation will lie in the terminal value, a calculation which is vulnerable to a sharp rise in interest (discount) rates," said Citi.

Recent winners of digital bank licences include Sea and the Grab-Singtel joint venture in Singapore, as well as platform players that are buying existing banks to relaunch as digital, such as Bank Jago in Indonesia.

Based on a sum-of-the-parts valuation, Citi has initiated a "buy" call on Grab-Singtel and Sea with a target price of S$3.44 and US$300 respectively.

While both digital banks have yet to disclose details on their exact business models, Sea in January acquired Indonesia's Bank BKE that was rebranded as SeaBank.

Meanwhile, Bank Jago will be the first pure digital bank in Indonesia to offer comprehensive digital banking services and products. With support from newly-merged entity GoTo Group, the bank can emerge a "major winner" in the digital banking space, said the report.

With 100 million monthly users in GoTo, it "should not be too difficult" for Bank Jago to have two to three million customers in 2021 and reach seven to eight million customers by 2024.

High mobile penetration, coupled with a young and tech-savvy population in Indonesia, should enable widespread adoption of digital banking services and allow the bank to establish strong brand recognition, loyalty and adoption at an early stage, said Citi.

Bank Jago is currently Indonesia's eighth-largest company by market cap and is expected to be included in the Indonesian MSCI within a year. Citi has forecasted a cost-income ratio of 20-25 per cent and return on equity (ROE) of about 25 per cent over the medium term. It has initiated a "buy" call on Bank Jago with a target price of 15,800 rupiah (S$1.46).

The launch of new digital banks in Asean will certainly impact the banking landscape and earnings/ROE outlook for incumbent banks.

While it may take five years or more for a new digital bank to attain a meaningful market share, the impact on incumbent banks' revenues through price competition could be immediate, said the report.

Consumer banking services is an area that is more at risk. For markets where digital banks are focused on financial inclusion, the potential losers may not be the major banks, rather non-bank financial companies. "We are especially mindful of fee competition, notably in Indonesia where fee spreads are arguably still high," said Citi.

Incumbents in Asia have responded by investing heavily in their own digital capabilities - a difficult and cost-heavy journey involving both cultural and technological change.

Banks like DBS, UOB and CIMB are launching their own digital banks, and more lenders could follow.

Singapore's banking trio have made significant investments and progress in digital transformation, developing open APIs and ecosystems, which may put them in a good position to face the challenge of the new digital entrants, said the report.

UOB is Citi's top pick in Singapore due to the bank's "clear strategy" for its digital bank, TMRW, which can be both an offensive move (acquiring new to bank customers in core regional markets like Thailand and Indonesia), as well as a defensive strategy - bringing back learnings from TMRW to enhance the digital service of UOB, while priming TMRW's millennial customers to become future UOB customers as they graduate through their financial lifecycles.

In 2020, TMRW's customer base exceeded 300,000, with 70 per cent of customers acquired being new to bank. These customers now account for 26 per cent and 12 per cent of UOB's retail customer base in Indonesia and Thailand, respectively.

"Rather than aiming to be an independent digital bank, in our view, TMRW will retain a symbiotic and synergistic relationship with UOB. Eventually, TMRW customer could migrate to be UOB future customers," said Citi.

Over time, a convergence in business models between the present new entrant digital banks and the fast-evolving incumbent banks can be expected in the region.

One key example of this is incumbent banks creating their own new partnership ecosystems, using open APIs to enable third-party companies to interface directly with the bank. Banks are also taking a page out of the Internet playbook and launching enhanced financial and lifestyle "superapps", said the report.