South Africa’s New Challengers

Out with the old, in with the new? Not quite, as the region’s incumbent banks are stepping up to the challenge presented by a spate of new, digital-only entrants that have no legacy system costs.

South Africa is by far the most developed market for financial services on the continent and is home to some of its largest and most sophisticated banks. But incumbent players now face the challenge of reversing recent earnings declines, while seeing off no fewer than five new “challenger banks” that will be entering the market in the coming year.

The Big Five’s woes were highlighted in a recent industry report by accountancy and advisory group EY, which shows how years of weak economic growth have undermined both consumer and business confidence, with demand for credit—from auto finance to corporate loans—drying up.

Ernest van Rooyen, Financial Services Africa partner at EY, notes that 2017 saw the weakest earnings growth the banking sector has seen in five years. “This is in line with tepid interest and revenue growth, although support from stronger margins and improved impairment charges helped offset some of the impact,” he states.

“Across the industry, low levels of new lending have brought revenue growth down to single digits, even where banks demonstrated good cost control,” says Chris Steward, head of financials and portfolio manager at Investec Asset Management. “That said, all major banks remained profitable and well capitalized, interest margins are holding up and credit quality is much improved—especially in the corporate space.”

Fee-Free Banking

The key question now is whether incumbent banks can defend the high margins on which their profitability is based when faced with potential disruption from a new wave of low-cost competitors.

One of these new market entrants is digital-only start-up TymeDigital, which grew out of a South African fintech that was bought by Commonwealth Bank of Australia; billionaire Patrice Motsepe’s African Rainbow Capital retains a 10% share in the bank.

TymeDigital’s ambition is to be “a complete game-changer.” It combines a Cloud-based system, with its own in-house Know Your Customer accreditation solutions to enable customers to open a no-frills bank account over their mobile phone. It applies cutting-edge technology to build an informal distribution network through self-service kiosks.

Another digital-only challenger bank is Bank Zero, the brainchild of tech entrepreneur Michael Jordaan and banking innovator Yatin Narsai. Together, the pair previously transformed First National Bank into an innovative, app-driven bank. Bank Zero is a further development on this concept, and is squarely targeted at South Africa’s large population of smartphone users, while its low-cost mutual structure permits zero-fee banking transactions.

Steward believes Bank Zero could make some inroads through its free-transaction offering, but warns that its revenue flow will then depend on whether it can attract sufficient volumes of deposits, when competitors are already offering attractive interest rates to their customers.

Having built up the multi-billion Discovery health insurance business, entrepreneur Adrian Gore is now launching a full-service retail bank as a direct competitor to the Big Five incumbents. As with other digital banks, Discovery can deliver banking services without the fixed costs of a nationwide branch and ATM network.

Steward, Investec Asset Management: All major banks remained profi table and well capitalized, interest margins are holding up and credit quality is much improved.

“Discovery’s health business has built up a large client base, which is also a rich source of data,” says Steward, “and its loyalty program could add banking services onto existing benefits. So, over time, they could make a success in the higher-income segment; Discovery is a credible competitor.”

Incumbents Fight Back

Also looking to gain traction in the retail market is the rescued—and now relaunched—African Bank, with Basani Maluleke, the first female bank CEO in South Africa, at the helm. “African Bank was a lending business,” she says, “but we are now rolling out a transactional bank. We need to develop affordable, appropriate products.”

Maluleke says the landscape has been altered over the past year, as incumbents modified their business models to reflect new aspirations. “African Bank is aiming to appeal to the mass market by offering extremely competitive deposits,” she adds. Steward says African Bank seeks to develop additional revenue streams and reduce its high legacy-funding costs by attracting retail deposits.

The South African Post Office’s long-anticipated launch of a full-fledged consumer bank could also prove disruptive, although its model is more like a development bank, and its core mission is to extend financial inclusion.

“A new Postbank will enjoy access to a widespread physical distribution network that will enable it to provide banking services in rural areas,” observes Steward, adding that it could attract government support. “But it remains to be seen whether this is a banking model that can generate an adequate return to private capital investors.”

Even before these new entrants are up and running, competition for retail customers has been fierce. South African retail bank Capitec has already proved disruptive, winning market share from its peers. Incumbents like Nedbank and Barclays Africa (rebranded as Absa) have responded by launching new entry-level accounts. But it remains to be seen how far such initiatives can reverse recent declines in bank earnings.

With both Barclays/Absa and Nedbank, profitability depends more on lower impairment charges than on generating new revenues, says Steward. Banks doing better are FirstRand Bank, he adds, which has led the way in boosting transactional volumes and client acquisition, and Standard Bank, which has the strongest earnings thanks to double-digit growth from its core banking operations and lower costs.

The big banks in South Africa are still focused on gaining a competitive advantage over each other, rather than seeing off the new wave of disruptors. To this end, they are pushing through internal transformation programs intended to streamline and simplify legacy business models.

All are investing heavily in technology or partnering with fintechs. “The shift to digital channels is competitive and growing fast, and requires major investment costs,” says Jane Fitton, Financial Services Africa leader at EY. “It is a critical component of any bank’s strategy and provides opportunities both from an operational-enhancement perspective as well as improving the customer experience.”

The key advantage of the new digital-only challengers is that they have no costly legacy systems and can pass on their lower operating costs to their customers.