What next for Australian banks?
Digital disruption and the Royal Commission
10 October 2018
In my view now is not the
time to ‘discount’ the impact
A recent research trip to the US to meet with banks, fintech firm and other financial services companies has reinforced my beliefs about how the collision of digital disruption and the Banking Royal Commission could change the shape of the banking industry in Australia:
- Successful disrupters often grow from a wedge – gaining rapidly in a narrow market before expanding further;
- Risk aversion in Australian banks post the Royal Commission may create a space, or wedge, that will be filled by disruptors;
- Incumbents do still have advantages and are fighting back in the US and other markets.
In the following paper, I discuss the US experience with digital disruption, and what the current environment means for Australia’s incumbent banks.
HIP TO BE SQUARE…
Recently, I walked into the San Francisco offices of
payments firm Square. It’s a very different scene from your
typical corporate office. There are chess boards in booths,
internal platforms for meetings and headphone-wearing
workers, fixed to screens full of code.
However, behind all these tech clichés, what has made
Square a success is its singular focus on empowering the
small business entrepreneur. Square now has the chance,
with millions of users, to broaden its service offering and
grow with them.
...or wedge shaped
Many successful disrupters create a wedge; they enter a
niche of financial services with a unique mission and lowcost
access to customers that allows them to scale. Then
they extend the offering to something broader that could
threaten the role of incumbents.
Looking across US fintech success stories so far, many have
followed this path, and the emerging backdrop in Australia
is creating similar conditions, making the ground more
fertile for disruptors.
Many successful disrupters create a
wedge; they enter a niche of financial
services with a unique mission and lowcost
access to customers that allows
them to scale. Then they extend the
offering to something broader that could
threaten the role of incumbents.
Some key examples discussed with experts during my
recent trip were:
- the aforementioned Square, which started with painsaving
payments terminals for small business that now
extend to an ecosystem of credit, cash and software
- a recent US IPO GreenSky which funds ~1.5 million
home-renovation customers accessed via HomeDepot
or the ‘contractor’ channel;
- UK-based Revolut, which has acquired two million
customers almost exclusively by word of mouth to a
prepaid currency card that offers no foreign exchange
spread or fees. It is now rapidly adding further products;
the original fintech pioneer PayPal, accessed customers
via the unique channel of eBay before becoming the
trusted vehicle for internet payments for 200 million+
accounts; it continues to promise twenty percent growth
All of these companies started narrowly, whereas those
that have failed have generally had issues with the cost of
customer acquisition or gone head to head with major
What will force Australia’s wedge?
In the US (and UK), ‘payments’ or ‘specialised lending’
have been key areas for disruption, but this hasn’t
happened meaningfully in Australia yet.
Advancing technology and changing customer behaviour
supports fintech disruption, but the challenges of earning
trust and acquiring new customers loom large. Australian
banks have defended well, and been innovative
themselves, but they could now be exposed differently.
My historical view had been that a focus on business-to-business
activities and partnering with the large players
would be the path to success for both fintechs and
incumbents in Australia, with large banks proving
Similar reforms on ‘Open Banking’ to that in the UK,
allowing customers to share banking data via application
programming interfaces (APIs) to third parties; should
open the door for a wider array of services. I discussed
the concept of Open Banking in greater detail last
November in Tales From The Road: Lessons From The
UK For The Australian Financials Sector.
But given the fragmenting effect that the ongoing
Banking and Financial Services Royal Commission is likely
to have on the big incumbents, should we be more openminded
to the little guys?
Filling the space left by risk aversion
The potential biggest takeaway from the Royal Commission
hearings may be on governance.
The impact on the mindset of boards and management towards risk aversion creates scope for disruption to have a bigger impact than it otherwise would have.
The impact on the mindset of boards and management
towards risk aversion creates scope for disruption to have a
bigger impact than it otherwise would have.
An encounter during my US trip highlights this theme of
risk aversion. A prominent litigation funder I met with in
New York said we could see a situation where “Board
members in Australia could be forced to dip into their own
pockets to pay for class action settlements after shortfalls
from insurance coverage”.
Whether he is right or not, this shines light on an idea that
risk aversion is going to create a space, or wedge, in
financial services that may potentially be filled by
Incumbents may be too busy to defend
I see that risk aversion may create years of additional
compliance spend and internal focus, leading to
management actions that aren’t consistent with defending
We are already seeing this backdrop driving Australian
banks away from any business line that is ‘non-core’ or
places reputation at undue risk. Wealth platforms, thirdparty
originated lending, auto lending, insurance, overseas
subsidiaries and high-risk lending are some of the
Exiting a lot of these relationship-building products not
only gives up the profit pools, but also the data insights
that could unlock the types of platform- style services
customers might want in the future.
This narrowness should make banks better at compliantly delivering core products but may create the space for new players to drive a wedge and disrupt them.
The scope for financial concierge-type services (cashflow
management; digital wallets; AI-driven wealth advice) as
possible future product ranges for digital banking is yet to
be fully explored; however, if banks give up many of their
peripheral services and associated data it seems likely they
would be less ready to enable future digital platforms.
It could be argued Australian banks have been living in a
constrained oligopoly, where protecting margins and
market share has been easy. Going forward, we could see
the banks fight over a narrower set of products and this
arguably means a weakening in the market structure. The
recent breakaway by NAB on mortgage re-pricing may
prove to be an early example.
This narrowness should make banks better at compliantly
delivering core products but may create the space for new
players to drive a wedge and disrupt them. Throw in the
ongoing litigation and a major adjustment from responsible
lending scrutiny and the backdrop could see incumbent
banks relinquish their natural advantages.
But big can be an advantage
The perceived backwardness of the large incumbent US
banks has been altered in the post-GFC rebuild toward
digitisation. This has influenced how they are handling
disruption, with many banks using the reinvestment period
to improve data extraction or launch new apps.
For example, this year alone Bank of America launched
digital initiatives including: Erica (digital AI), digital
shopping, digital wallet (a store of users’ payment details on
a digital device), mobile client onboarding, digital rewards
dashboard, and digital wealth management.
Efforts to be all things to all people, to have ‘top of digital
wallet’ status (i.e. be the first app to be reached for) and to
cross sell wealth products – a form of vertical integration –
are all still key tenets of the US banks’ proposition. This is a
contrast to the prevailing trend in Australia.
I was told by one US fintech they “view their main threats
as GoldmanSachs’ digital bank called Marcus, and
Amazon”. This tells you incumbents and the connections
they have still drive some natural advantages.
US banks are outspending the smaller players on financial
apps and customer experience development. Bank of
America now has 36 million active digital accounts, the toprated
app, and spends US$10 billion p.a. on technology. This
shows how digital banking has become as much about an
arms race as a marketing race.
Large US banks also appear to have a growth mindset to
digital banking; viewing it as an opportunity to win share
and grow the wallet. For example, Zelle, which is part
owned by a number of key banks, is now a larger peer-topeer
(P2P) platform than the PayPal-owned Venmo.
Additionally, many of the fintech players have really
struggled to scale their direct-to-consumer businesses with
customer acquisition costs or underwriting issues; only
those with tied access to customers are showing success at
present. Businesses like the original P2P lender,
LendingClub, have found regulatory compliance a big
hurdle, despite scaling to a level of 12 million loan
HIGH TECH, HIGH TOUCH
The US experience is showing that the traditional
virtues of banking, staff engagement and customer
satisfaction, will still be relevant, with many players
talking about being “high tech and high touch”.
The Net Promoter Score (NPS), which is used to gauge
the loyalty of a firm's customer relationships, is typically
quite poor for the big-4 Australian banks, around -10 to
-202. In the US there are examples of banks where this
score is more positive and they are placing greater
importance on relationships.
For instance, during my trip I met a bank called First
Republic that generated an NPS of +75 in 20173. This
was driven by a relentless focus on a single point of
contact for the customer, staff tenure and delivery of a
combined wealth and private banking proposition.
On the theme of bank customer loyalty, I also heard of
another bank, City National, which apparently still
retains many Hollywood stars as banking clients
because it is claimed that in 1963 the bank manager
gave Frank Sinatra cash in the middle of the night to
pay a ransom over his son.
2Source: Statista, February 2017.
3Source: First Republic Form 8K; filed July 13, 2018.
Donn't discount disruption for Australian banks
The large US banks are showing leadership on digital
investment by chasing new customers outside of their
usual markets and continuing to push holistic customer
If Australian banks narrow their focus to just core
products, they will have a real challenge turning this
disruption, or perhaps more aptly the ‘creative
destruction’, of their business models into a positive
story for earnings growth.
It leads to the question of whether Australian banks can
find a digital ‘cost out’ story to drive growth? The path
to much lower digitised cost bases appears long and
distant. Some US groups like Bank of America and
American Express have managed to reduce nominal
costs, though this was typically through traditional ‘lowhanging
fruit’ cost-cutting. Most US banks, in fact, are
not seeing anything better than flat costs, and view the
tech spending arms race as ongoing.
Australian bank share prices currently reflect
expectations of low growth, returns on equity remaining
below historical levels and little benefit given to the
banks for the healthy state of Australian corporates.
The Royal Commission has seen investors overreact on
some factors, and if the banks can mount the perceived
comeback that has been evident in some of the US
banks, they might even be considered cheap at the
If Australian banks narrow their focus
to just core products, they will have a
real challenge turning this disruption,
or perhaps more aptly the ‘creative
destruction’, of their business models
into a positive story for earnings growth.
However, the bad news is that expectations of a return
to the banking glory days (once the dust has settled on
the Royal Commission) are likely to be disappointed by
actual meaningful disruption by non-bank players. This
is in part due to the risk- averse regulatory and
In my view now is not the time to ‘discount’ the impact
of disruption. We see this creating a long, slow burn to
subdued aggregate earnings and relatively static share
prices for the banks.
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