Banks, Big Tech have mobile banking edge in EMs

Singapore

THERE is a viable business for financial firms which want to expand into emerging markets through the use of mobile banking, a fresh McKinsey study on Tuesday suggested.

But the caveat is that this approach seems more compelling for large companies than it is for smaller firms, the report suggested. These large companies would include banks, telcos, and Big Tech.

The benefit of economies of scale applies not only to decreasing fixed costs from technology spending, but also higher efficiency in handling cash, which remains prevalent in emerging markets.

The McKinsey study showed that a mobile banking business in emerging markets can hit a 35 per cent margin once it reaches optimal scale. But the significant upfront spending means that small firms may need to spend as much as two times more on each customer to reach that scale.

A breakeven point for mobile banking in emerging markets is estimated by McKinsey to be about US$20 million in revenue, with annual transaction value hitting some US$2 billion.

To be sure, this breakeven figure would not apply to all emerging markets. McKinsey noted that much of its focus was on numbers from East Africa, though it had also included representatives from South-east Asia.

In cash-based economies, customers must be able to efficiently deposit and withdraw cash into and from their payment accounts. Many mobile banking players rely on agency networks - either hiring third-party sales representatives, or drawing on an existing retail network - to ensure that customers can get access to cash, or deposit funds.

Here is where economies of scale power up the engine. Mobile banking providers stand to improve profitability "meaningfully" by increasing the number of digital transactions each time cash is put into the system, McKinsey said.

Margins on transactions can exceed 75 per cent, as fees are large compared to the low costs to the provider, which are using automated systems and digital user interfaces.

"All evidence indicates that cash will not disappear anytime soon. Even in Norway, for example, the country with the largest share of digital payments globally, 17 per cent of all payments are transacted in cash," the report said.

"To improve profits, providers should look to grow digital transactions even if it means also increasing the number of cash-in-cash-out transactions."

As margins on cash deposits and withdrawal alone are lower - at about 20 per cent to 30 per cent - even small cost reductions can impact overall economics. Conversely, such cost jumps can turn players unprofitable.

There are more conventional pieces of evidence that big is still beautiful when it comes to mobile banking in emerging markets.

What's key is IT spending, which represents about US$1.5 million in annual fixed cost for a mobile banking system. Again, that spending is significant for small providers, but is minimal for large players.

But beyond IT costs, there are also the costs of real estate, and marketing, with marketing expenses alone about 40 per cent higher for subscale mobile-banking providers, compared to providers operating at scale, estimated McKinsey.

This means financial companies looking to expand into emerging markets through mobile banking would need financial stamina.

"To gain the benefits of scale, providers must invest heavily and with long time horizons," McKinsey said. "This holds true across the world for Internet players in network businesses - firms such as Alibaba and Google have invested significantly in long-term growth and market capture, even when this means immediate losses."

Much of the focus on financial inclusion has been on lifting people out of poverty by introducing them to financial services. McKinsey noted the same, saying that mobile banking can be a lifeline.

"It brings the benefits of financial services to those who currently lack access, and thus enables them to take initial steps towards healthier financial lives."

But regulatory changes meant to spur inclusion can significantly shift the business dynamics of mobile banking players. For example, caps on fees can make the mobile banking business an unsustainable endeavour, particularly for smaller firms. So while such caps are intended to make services affordable to poorer users, they hinder profitability and make growing the customer base more difficult, said McKinsey.

"Even when tariff caps do not make a type of transaction unprofitable, they increase the transaction value required through the system for a provider to be profitable overall," McKinsey added.

"They may also make some customer segments unappealing for providers to serve, if the expense to reach them outweighs the benefit from gaining more users."