Can SA's new challenger banks knock out the 'big four'?

For two decades, SA's banking sector has remained largely the same. The advent of Capitec, in 2001, showed that customers were desperate for something different. Now, three new banks all backed by powerful SA business personalities are opening their digital doors, offering something entirely different. So what can they offer that's new, and how much of a threat is this for the 'big four' banks?

28 MARCH 2019 STEPHEN CRANSTON

Financial services used to change slowly. Twenty years after Douw Steyn launched the direct-to-consumer insurer Auto & General in 1985, insurance was still largely sold through brokers, and index funds still accounted for a tiny portion of investment assets.

Banking changed even more slowly. More than 25 years after the launch of the internet, most banks still distribute a large portion of their products through a branch network. These branches will still be perfectly recognisable to anyone visiting SA for the first time in 30 years. None of the big banks will rock the boat; they want to protect their collective income. That era has come to an end. In the past few months, three new banks have launched with a leaner, cheaper business model that will change the face of SA banking Discovery Bank, TymeBank and Bank Zero.

It's been a long time coming. After Saambou and Fidelity Bank collapsed in the early 2000s, the SA Reserve Bank was for a long time reluctant to let new banks open. But these three new banks are backed by formidable business personalities with deep pockets.

Discovery Bank is part of the wider group run by CEO Adrian Gore, which began as a health-care company in 1993. Discovery boasts Remgro associate Rand Merchant Investments (RMI) as its anchor shareholder.

Tyme Bank is controlled by African Rainbow Capital (ARC), an investment company controlled by the eclectic Ubuntu-Botho group headed by Patrice Motsepe. As the Forbes rich list has it, Motsepe is one of the 1,000 wealthiest individuals in the world, with a fortune of $2.4bn. Before it was bought by Motsepe's company, TymeBank was owned by the Commonwealth Bank of Australia (CBA), one of the world's top 10 retail banks. MASTER OF BUSINESS ADMINISTRATION - ACADEMIC AND ASSESSMENT CALENDAR - DISTANCE

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As for Bank Zero, the most entrepreneurially based of the three, it shows how far the Reserve Bank has come that it got the green light. Bank Zero is run by a maverick group of former FNB executives, most of them with strong technology backgrounds, with a few family and friends as shareholders. The chair and figurehead is the former FNB boss Michael Jordaan, based in Stellenbosch.

Somewhat ironically, Jordaan is Motsepe's partner in the data-only telecom network Rain. The Bank Zero CEO, Yatin Narsai (former head of FNB retail), runs the business day-to-day from Bryanston.

Discussing the rationale for the bank in an interview with the FM, Narsai says SA ranks among the five countries with the highest bank fees in the world. "This is intolerable in such an unequal society, but then the rest of the bottom five were similarly unequal countries in Latin America," he says.

No-one can ignore the competitive threat of cheap banking. Narsai says he personally will save R2 000 a month from his personal and business accounts, when Bank Zero goes live and he can move accounts. "Low fees will become the new normal and I hope that penalty fees will disappear altogether," he says.

The question, however, is what the existing big four banks FNB, Standard Bank, Absa and Nedbank will do to counter the threat. "The big banks ignored Capitec in the early 2000s," says Louis Chetty, head of financials at Stanlib, "and lost considerable market share. I am sure they will not make the same mistake again."

Capitec has more than 10-million customers, who will have been enticed, in part, by the much lower cost of banking. And yet the big four still have 83% of all bank deposits in the country and 92% of all mortgages, which shows how concentrated the market still is.

Harry Botha, a banks analyst at Avior Capital, says it could take three to five years for the challenger banks to make material inroads into the large banks' earnings.

Discovery, TymeBank and Bank Zero are pursuing a branchless model, with their apps being their shop window. This means SA isn't far behind the rest of the world: the first app-only current account in the UK was introduced by Starling Bank just two years ago. Perhaps if the Reserve Bank had been more open-minded, SA could have beaten them to the punch. MASTER OF BUSINESS ADMINISTRATION - ACADEMIC AND ASSESSMENT CALENDAR - DISTANCE

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But, globally, this is the trend. No-one should have been surprised by Standard Bank's announcement two weeks ago that it was closing up to 15% of its branch network or 91 branches. Botha says Standard's natural market share has fallen thanks to the success of Capitec and FNB, in different parts of its client base.

Standard Bank CEO Sim Tshabalala called it "realigning the retail and business banking model to the changing needs of customers". And, of course, the convenience of digital banking makes so much more sense than travelling to a branch and queuing.

TymeBank chair Coen Jonker tells the FM: "The banks have done their best to protect their legacy income streams for years, and the transactional fees on simply taking money in and out of accounts is the hardest to justify. As new banks we won't have that legacy to defend."

The big four banks have long operated as if they were an informal cartel. Even the one entrant in the past 20 years to grow to large-bank status, Capitec, has adopted a traditional branch-based distribution model.

Only Investec has operated without branches but to a narrow spectrum of high net worth clients. To see what sort of riches are up for grabs, consider Capitec's trajectory. In its first year on the JSE in 2002, Capitec made revenue of R270m, with just a smattering of clients. By August 2018, it was clocking up R9.3bn in operating income with its 10.5-million customers. Its share price has reacted accordingly: R10 000 invested in the bank at the beginning would now be worth R7.2m. MASTER OF BUSINESS ADMINISTRATION - ACADEMIC AND ASSESSMENT CALENDAR - DISTANCE

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Fees were a big part of this success. Capitec has a nominal monthly fee of R5, with R1 charged for each digital transaction. Cash withdrawals are more expensive at R6 for the first R1 000 at a Capitec ATM, or a flat R1.60 at till points of retailers like Pick n Pay or Shoprite. As many of Capitec's transactional clients earn interest of 5% on their deposits, they often get more money coming in than they pay in fees.

These new banks would appear, in part, to be targeting that market. However, Chetty says clients who have a loan with Capitec are unlikely to move their transactional accounts to the new banks in a hurry. "Banking will never be free," says Capitec CEO Gerrie Fourie in an interview with the FM. "Even at Capitec, we have a high fixed-cost base."

Interestingly, Capitec is the only bank that is actually increasing its branch footprint, even though 2.2-million clients have migrated to the app and 4-million to the USSD (SMS-based) transactional platform.

At the moment, Capitec has 840 branches, though many are smaller than those of the big banks. The branches have proven invaluable as the predominant sales point for the half-a-million Sanlam funeral policies sold through Capitec over the past year.

Avior's Botha says SA is still a long way from a zero-fee banking regime, even among the new entrants. But fixed monthly fees and charges for electronic transactions could come to an end sooner rather than later.

Discovery Bank will charge both sets of fees at least for now.

Gore says banks operate on three legs: fees, interest and rewards. Some banks (like Capitec and the other newcomers) will offer competitive fees and attractive interest MASTER OF BUSINESS ADMINISTRATION - ACADEMIC AND ASSESSMENT CALENDAR - DISTANCE

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rates on accounts but no rewards programme; while the large banks pay little or no interest on current accounts but have decent rewards programmes.

Gore says Discovery will not attempt to beat the market on fees, for a combined current account and credit card.

Discovery Bank's lower-income clients (those earning less than R300,000 a year) will pay between R149 and R186 a month in fees; middle-income customers will pay between R213 and R240; and higher-income clients will pay between R275 and R440. For a pure transactional account the fee will be R60 to R120, but as Discovery has no ATMs, cash withdrawal fees will be higher.

But if it won't compete on fees, Discovery Bank will be second to none with its Vitality Money rewards programme, and the sophisticated way in which it encourages the right financial behaviour.

Discovery Bank will match Capitec's 5% interest rate on positive current account, and add an extra 1.5% for those in the top tier of the Vitality programme.

The three new banks are not just aiming for the tech-savvy. TymeBank's former parent, CBA, has a larger market cap than the entire SA banking sector, though it took a softly-softly approach to the new bank. Even before Tyme was registered, it offered money transfer services from Pick n Pay.

Though Tyme doesn't have any of its own branches, it will have 750 points of sale through Pick n Pay and Boxer stores. This gives it reach into the main urban areas, as well as the rural areas where few banking services are typically available. Boxer customers are more likely to be unbanked, so could prove the most fertile hunting ground for Tyme.

Most transactions are free if carried out at Pick n Pay or Boxer, and cost only R2 if done elsewhere, and the bank pays up to 10% interest on positive balances. TymeBank has such low costs because it is cloud-based and highly scalable, and has minimised the bells and whistles. Incredibly, there are just 125 staff keeping the bank running. Clients can join through the TymeBank website, but by far the most popular recruitment tool has been self-service kiosks, which provide a new card within five minutes.

CEO Sandile Shabalala says the bank will start offering loans next year. It plans to offer keener lending rates because, like Capitec, it will be able to cross-subsidise its transaction and deposit books from its loan income. The tipping point for Tyme, at which it becomes profitable, is 2-million customers and 700,000 loans. MASTER OF BUSINESS ADMINISTRATION - ACADEMIC AND ASSESSMENT CALENDAR - DISTANCE

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It is almost an accident that Motsepe's ARC took full control of the bank after CBA pulled out suddenly to retreat to its home market and cut exposure to emerging markets.

Johan van Zyl, the co-CEO of ARC (and chair of Sanlam) says he was pleased CBA was the controlling shareholder while the bank was being registered because it is a bureaucratic, by-the-book organisation with huge experience of banking regulation.

"We would like to bring in an equity partner as we prefer to hold minority positions in companies, not the 73% we currently hold, but it is not an imperative," he says.

Van Zyl says the Reserve Bank does not want TymeBank to become a Sanlam group company as it wants to keep banks and insurers as separate as possible. TymeBank, he says, will ride the wave away from cash transactions to digital payments.

"We expect the amount of cash in the system to be cut back by two-thirds over the next three years. Increasingly shareholders in the Ubuntu-Botho group find carrying cash dangerous. We were able to issue 1-million cards to members of the Zion Christian Church to facilitate cashless transactions," he says.

For now though, Pick n Pay stores are more than happy to offer excess cash to TymeBank customers at no charge. The retailer's deputy CEO, Richard van Rensburg, says Capitec also recommends its customers draw money at Pick n Pay tills because it is far cheaper than using an ATM. And a central feature of TymeBank is its access to the information gathered by Pick n Pay on the 11-million members of its Smart Shopper programme, which provides rewards points on all purchases, not just at Pick n Pay. And unlike Discovery, that benefit is not confined to healthy foods. In a much less judgmental way, all purchases qualify.

You might have expected Pick n Pay to have cold feet after the failure of its Go Banking venture with Nedbank in the mid-2000s. But Van Rensburg argues that Go Banking offered similar services to Nedbank, whereas TymeBank has developed products exclusively for digital clients. He says he would not try to set up a bank as a subsidiary of a retailer again, but an alliance between a retailer and a bank makes sense.

Pick n Pay CEO Richard Brasher is also the founder of Tesco Bank, which is owned by the UK's largest supermarket chain. MASTER OF BUSINESS ADMINISTRATION - ACADEMIC AND ASSESSMENT CALENDAR - DISTANCE

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Motsepe and his team are facing some other strong personalities over at Bank Zero. Jordaan may just be the nonexecutive chair of Bank Zero, but with his deep knowledge of new technologies, the market seems confident that his bank will be impressive from the start.

Narsai, as head of FNB retail, is even more deeply entrenched in IT than Jordaan. "I am impressed that TymeBank has signed up 120,000 customers in a few months," he says. "[It shows] there is pent-up demand for a good-value, no-frills bank account. But we will be offering considerably more sophisticated functionality."

Other FNB renegades at Bank Zero are chief risk officer Lezanne Human (who also moonlights as the informal head of public affairs), and co-founder and CFO Lin Wiid. Bank Zero, as a mutual bank, will focus on deposits and transactional banking and will not offer loans for the foreseeable future.

"The intention is to keep capital as lean as possible, and considerable capital is needed to roll out loans," says Narsai. It will also focus on the business banking market, where margins are still chunky.

Narsai promises a "creative" solution for clients who might go modestly into the red. But he also hopes to nurture a savings culture through attractive interest rates. Initially, the team had planned to focus on high-margin areas, particularly remittances from neighbouring countries, but they soon realised they had the capability to launch a full-service bank.

Jordaan tells the FM that Bank Zero, launching in the second half of 2019, will make money through the interest it charges, fees on third-party transactions and commissions MASTER OF BUSINESS ADMINISTRATION - ACADEMIC AND ASSESSMENT CALENDAR - DISTANCE

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on prepaid products such as airtime. "But with our low break-even you can expect lots of zeros where other banks charge fees," says Jordaan.

Mark Elliott, president of Mastercard Southern Africa, says he is working with Bank Zero to develop a new kind of card that can deliver better security, which is appropriate for today's increasingly mobile and digital customers.

Bank Zero also keeps costs down by using the cloud, but the heart of the business will be its IBM LinuxOne enterprise server, which uses (free) open-source software. Perhaps Bank Zero's most serious competitor, at least in the small to medium business sector, could be Mercantile, once it is revitalised under Capitec's ownership.

Narsai says most banks opt for off-the-shelf IT systems, where both the risk and capital requirements are significant. Bank IT managers naturally gravitate towards packages conforming to past norms, which tend to create a "me too" starting point.

"We have preferred to build our platform to clearly defined bank specifications. We are very comfortable doing this with our deep expertise. And we can design from the ground up for today's issues such as regulation and cybercrime," he says.

Capitec's Fourie warns, however, that while new fintech technology providers might be adding value, they fall short on two issues handling volume and maintaining security. It'll be interesting to see how Bank Zero navigates this.

For Jordaan, it's a natural evolution. Now living in Stellenbosch, he became CEO of FNB when he was just 36, creating an institution that grabbed plaudits as "the world's most innovative bank" in 2012.

He says he thrived in the entrepreneurial FirstRand culture fostered by the three founders GT Ferreira, Laurie Dippenaar and Paul Harris who embraced start-up ventures such as Discovery and Outsurance. This inspired him to become a backer of small business.

Jordaan left FNB in 2013, because he says 10 years of commuting from Stellenbosch to Johannesburg was enough. There was no love lost between him and Discovery (another FirstRand subsidiary at the time), which he called the enfant terrible of the group and a disrupter, in the days when that was still a swear word.

Jordaan says all the Bank Zero shareholders are active as executives or active directors, with skin in the game.

"Without a big corporate shareholder, we can take a much longer-term view," he says. "We have a cohesive strategy to bring significant customer benefits without the pressure to produce short-term profits." MASTER OF BUSINESS ADMINISTRATION - ACADEMIC AND ASSESSMENT CALENDAR - DISTANCE

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Mutual banks might have a bad name after the collapse of VBS last year under a mountain of fraud, but one of the benefits of the structure is that it allows customers to become shareholders.

If Bank Zero's model is simple, Discovery Bank's is the opposite.

The launch included a 70-page "thought leadership" document with chapters on such warm and fuzzy notions as "shared value", "behaviour change" and "people-centric" design. Still, Discovery Bank's CEO, Barry Hore, promises that the app will be simple to use, once clients get used to it. "It is multifunctional, a bank branch in the palm of the hand," he says.

Interesting features of its model include Discovery Pay, which allows clients to pay any other client without needing to register the person as a beneficiary. Pharmacy co-payments can also be automatically deducted from the bank account.

To date FNB has been the leading bank for innovative features, such as registering as a customer using a selfie from your phone. But Hore says the Discovery platform will ensure that bank customers never need to visit a branch, even to open an account, and from day one cardless capabilities such as Samsung Pay, Garmin Pay and FitBit Pay will be available.

The Discovery Bank app went live this week, and the first stage is to migrate former clients of Discovery Card (which was backed by the FNB platform) into the bank. It will necessarily be a slow process to avoid anything going wrong. But by June, the first 10,000 clients are expected to be onboard.

Discovery's advantage is that unlike the other two new banks, it is already a household brand. It also has a good chance of capturing the majority of its credit card clients (bought back from FNB) and a sizeable slice of its medical aid and insurance clients. Already, the group's Vitality programme has cult status among some, and if you believe MASTER OF BUSINESS ADMINISTRATION - ACADEMIC AND ASSESSMENT CALENDAR - DISTANCE

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their marketing, physically fit people are less likely to be financially irresponsible. And the ability to cross-sell was an important reason for setting up the bank in the first place.For those who are on the main Vitality Health programme (Discovery medical aid members or life policyholders), and who hold a Discovery bank account, there will be plenty of benefits. For example, those on the higher Vitality status can get free membership at Virgin Active or Planet Fitness gyms, while the discounts for flights on Kulula can be up to 75%. There are also cash-back rewards for healthy food at Woolworths and Pick n Pay.

Hore insists you don't have to be a gym bunny to get a good deal from the bank people with no other Discovery product still get a 25% discount on fuel and healthy food. But these are the frills. Discovery has not yet revealed how it plans to recoup the considerable start-up costs. It has spent close to R4.5bn between developing the bank systems (which, like those of Standard Bank, are based on SAP products) and buying back the Discovery credit card from FNB. Gore says Discovery could not opt for a simpler cloud-based solution, as Tyme Bank has done, because its system needs to accommodate the complex links between the bank and its Vitality programme and the company's health, life, investment and insurance businesses.

This suggests it will take longer for Gore's bank to make a profit than either of its more nimble competitors, Bank Zero and TymeBank, and the marketing spend will be higher. Discovery estimates it could take five years to turn profitable. Gore says the bank has been built from the ground up with the latest technology and features including the most advanced fingerprint and facial recognition systems as well as the ability to add accounts with a few clicks. But he is pinning much hope on the behavioural approach and rewards system, which he believes is the differentiator.

Gore challenges the view, expressed by FirstRand CEO Alan Pullinger recently, that SA's banks already use a behavioural approach to assess the quality of their clients when it comes to risk. "We don't agree," says Gore. Most banks reward clients for taking out more products, which specifically increases their debt and credit levels, he says. This means there are now 8-million more credit-active consumers than employed people a big risk to society.

"We don't push products, but encourage [customers] to follow key behaviour to secure financial health. They get the tools to help them through the Vitality Money programme," he says. Still, it's clear that Discovery Bank won't be matching the costs of TymeBank and Bank Zero item-for-item, at least for the average client. Instead, its sales proposition is to help clients achieve financial health and then reward them. Hore says it will set personalised goals based on an individual's circumstances, and will have a wider product range on day one than its rivals. Discovery will offer credit, transactional products and savings products. MASTER OF BUSINESS ADMINISTRATION - ACADEMIC AND ASSESSMENT CALENDAR - DISTANCE

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The bank will also offer dynamic interest rates. This means that its best customers (not necessarily its richest), could pay 6% below the market rate for debt and earn 2% more for savings. Hore says Discovery's "shared value" approach is not meant to punish those who don't achieve perfection, but rather to nudge people to make better choices.

If the bank takes off as Gore expects, there is plenty of scope to export this model too. While Gore says the bank will start as a purely SA venture, he isn't ruling out exporting a banking version of the Vitality Shared Value model at a later point.

Discovery Bank might be branchless, but it will have a handful of hi-tech walk-in centres. It will rely heavily on its network of agents and brokers to push clients towards the bank.

This network of brokers and agents is something that TymeBank and Bank Zero don't have. While Bank Zero is entirely app based, Tyme at least enjoys some advertising through its black and yellow machines at Pick n Pay stores, and has started flighting prime-time TV adverts to lure clients. Chetty says Bank Zero needs to develop a brand and requires a professional marketing campaign to do it. None of the team has marketing experience except for Jordaan, and that won't be enough to build a brand even with his Steve Jobs-style charisma.

While there's electricity in the air in the banking sector for the first time in years, it won't be a one-way bet. There is, after all, the cautionary tale of SA's first digital bank, 20Twenty, which launched in 2001 using Saambou as the backbone. 20Twenty never got to critical mass, with just 40,000 clients, and closed in 2006.

But the fact that TymeBank already has 120,000 clients is evidence that perhaps the time is now right. Narsai says that while 20Twenty had a huge marketing budget and a limited range of products, the architecture was quite primitive by today's standards and the benefit from lower fees was limited.

WHAT IT MEANS

Three new banks are set to change the face of SA banking with a leaner, cheaper business model

Back then, there were fewer smartphones (it was the age of BlackBerry) and the environment wasn't inherently as friendly for digital products as it is today. 20Twenty, for example, operated largely through a call centre, and the customer experience was often indifferent.

Though price alone might not be enough to propel the new banks into profit, they are launching at a time of considerable unhappiness over bank fees. It is easier than ever, through apps, to compare fees. Until now, none of the large banks has been prepared to jeopardise their lucrative income stream from transactional fees with a price war. But now they will have no choice. MASTER OF BUSINESS ADMINISTRATION - ACADEMIC AND ASSESSMENT CALENDAR - DISTANCE

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Says Botha: "The big banks will cut fees, but only gradually they need to cut costs first before they can afford to do so. "At least, in most cases, the big four banks still own the relationship with the customer and can persuade them to stay. Botha says they can be expected to increase their credit spreads on loans to make up for the lost fee income. Capitec is likely to be the least affected, says Chetty, given that it already has a competitive current account with low fees.

This means it will be the big four who will bear the brunt of the industry disruption. Already they're scrambling, introducing innovations like joining up with just a selfie. But they may have left it too late to ride the tsunami of change.

https://www.businesslive.co.za/fm/features/cover-story/2019-03-28-can-sas-new-challenger-banks-knock-out-the-big-four/

Questions:

1.1 Undertake a SWOT analysis of a challenger bank and a traditional 'big four' bank. (16)

1.2 "The big four banks have long operated as if they were an informal cartel".

Do you agree with this view? Justify your answer. (6)

1.3 Evaluate the business model of the challenger banks mentioned in the article. (12)

1.4 Critically discuss the 'entry' strategies of the challenger banks. (9)

1.5 "it will be the big four who will bear the brunt of the industry disruption".

About this view:

1.5.1 Discuss, with reasons, the strategies the 'big four' banks should adopt. (8)

1.5.2 Discuss the elements of change management that the 'big four' banks should undertake to counter the threat of the challenger banks.