Friday 23 Feb 2024
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This article first appeared in The Edge Malaysia Weekly on December 21, 2020 - December 27, 2020

BANKS in Southeast Asia may come out of the current crisis brought on by the Covid-19 pandemic relatively better than their peers elsewhere in the world. However, this should not stop them from continuing to transform to become more nimble and agile amid challenges ahead, says global management consulting firm McKinsey & Co.

Its senior partner Guillaume de Gantès notes that banks in the region entered the crisis on a better footing than their peers. “Along with those in other emerging markets, they experienced substantially higher growth, their return on equity (ROE) on average was at least five points higher than those in mature markets (about 15% versus 9%), higher than the cost of capital. However, their ROE trend was negative, as opposed to the rest of the world, which was positive,” Jakarta-based De Gantès, who leads the firm’s financial services practice in Southeast Asia, tells The Edge.

Unlike the 2008 global crisis, the current one did not start with banks. In fact, in many cases, they have been part of the “solution” by channelling government support, he says. Nonetheless, they will still be impacted as the coronavirus weighs on economies.

“We expect the banking system to pull through 2021 with limited bank or system failures. The likely immediate impact that we will see will come from severe credit losses,” says De Gantès.

“Subsequently, amid a muted global recovery, banks will face a profound challenge to ongoing operations that may persist beyond 2024. Depending on the scenario, between US$1.5 trillion and US$4.7 trillion in cumulative revenue could be lost globally between 2020 and 2024.”

In Southeast Asia, the scenario that is deemed most likely by bank executives is that of a recurrence of Covid-19 outbreaks, followed by slow long-term growth. This is likely to translate into a revenue decrease of 34%, after risk costs, according to McKinsey’s estimates.

The consulting firm says that while this is better than the expected impact on developed regions such as the US and the EU, it is more severe than in other emerging markets due to weaker currency performance, higher trade reliability with China and weaker micro, small and medium enterprise (MSME) asset quality performance.

“In this context, banks in Southeast Asia are likely to emerge from the current crisis in comparatively stronger positions, due to higher rates providing more margins on deposits, more demand for sustainability loans and high digitisation momentum created by new customer habits formed during the pandemic,” says De Gantès.

“However, this relative strength should not limit the appetite to transform. Banks should build more nimble organisations, build better scenario-planning for risk management, leverage new types of data and adopt a challenger mindset.”

McKinsey, in its annual global banking review released earlier this month, says under its base-case scenario, US$3.7 trillion in cumulative revenue could be lost by banks between 2020 and 2024 — the equivalent of more than half a year of industry revenues. Under that same scenario, it foresees ROE declining from 8.9% in 2019 to 4.99% in 2020, and to 1.5% next year. At the trough in 2021, it estimates that ROE will sink to -1.1% in North America, -1.8% in Europe and -0.2% in developed Asia.

De Gantès predicts that banks in the larger Asia-Pacific, excluding China, are likely to face strong ROE erosion (estimated at about 860 basis points) between 2019 and 2021 as the first wave of Covid-19 impacts start to hit the banking system. “Our models suggest that 2021 ROEs will be negative for the region,” he says.

“In the short term, two-thirds of the drop in profitability will be attributed to the increase in risk costs, while the remaining 33% drop will come from minor decreases in margins and volumes. Of course, government decisions on things such as payment holidays, for example, can change this scenario substantially.”

However, the scenario will change over time. “Risk costs will subside and our scenarios suggest that margin and volume erosion will accelerate,” says De Gantès.

“On average, growth will be reduced by two to three points a year between 2021 and 2024 in the region. That’s US$250 billion in lost revenues, after risk, for APAC ex-China banking in 2024. Both margins and volume, about 50% each, will contribute to this ‘loss’.”

Meanwhile, he notes that Southeast Asian banks’ shift towards digitalisation has been “fast, by any measure”, but could be even faster. “We have seen an increasing amount of pressure and the need to digitalise within banks as their customers are experiencing a rapid increase in digital penetration. Our research shows that emerging Asia has seen a jump of 1.5 to 3 times in digital banking penetration — Malaysia, at 1.6 times — in the last three years, as well as a jump in mobile adoption across all banking activities,” he says.

De Gantès points out that banks in Southeast Asia have, in fact, been world-leading in many cases. They have increased their focus and investment in digital to reinvent banking as we know it across all aspects, from products and delivery models to risk.

“However, Covid-19 has proved that this shift could be even faster. Banks have been able to make more decisions in a week than they used to make in a month,” he says.

“Customer adoption has massively accelerated. In some parts of financial services, we have seen an acceleration of three to six years in the last six months alone.

“Employees saw more changes in their way of work during the first few days of March/April than in the previous five years. We believe this pace of change can and needs to be kept after the current crisis, and banks can ‘hardwire’ the nimbleness they have acquired.”



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