Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 276

Digital disruption and the Royal Commission

Hip to be square …

Recently, I walked into the San Francisco offices of payments firm Square. It’s a very different scene from the typical corporate office. There are chess boards in booths, internal platforms for meetings and headphone-wearing workers staring at 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 finance disruptors create a wedge. They enter a niche of financial services with a unique mission and low-cost 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.

Some key examples of US fintech disruptors include:

  • Square, which started with pain-saving payment terminals for small business that now extend to an ecosystem of credit, cash and software services.
  • 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, which accessed customers via the unique channel of eBay before becoming the trusted vehicle for internet payments for 200 million+ accounts; it continues to promise 20% growth rates.

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 banks.

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 behavior 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 to a different challenge.

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 particularly resilient. But given the fragmenting effect that the ongoing Financial Services Royal Commission is likely to have on the incumbents, should we be more open minded to the little guys?

Filling the space left by risk aversion

The 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 otherwise. It’s possible that risk aversion will create a space, or wedge, in financial services that may be filled by disruptive firms.

Risk aversion may create years of additional compliance spend and internal focus, leading to management actions that aren’t consistent with defending against disruption.

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, third party originated lending, auto lending, insurance, overseas subsidiaries and high-risk lending are some of the examples.

A look into customer futures

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.

The scope for financial concierge-type services (cash flow management, digital wallets, artificial intelligence driven wealth advice) as possible future product ranges for digital banking is yet to be fully explored. 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 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 we could see incumbent banks relinquish their natural advantages.

Don’t discount disruption for Australian banks

This leads to the question of whether Australian banks can find a digital cost reduction 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 ‘low hanging 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 moment. However, the bad news is that a return to the banking glory days (once the dust has settled on the Royal Commission) is likely to be compromised by meaningful disruption by non-bank players. This is in part due to the risk- averse regulatory and management response.

Now is not the time to ‘discount’ the impact of disruption. We see this creating a long, slow burn of subdued aggregate earnings and relatively static share prices for the banks.

 

Matthew Davidson is a Senior Research Analyst at Martin Currie Australia, a Legg Mason affiliate. Legg Mason is a sponsor of Cuffelinks. This article is for general information only and does not consider the circumstances of any individual.

For more articles and papers from Legg Mason, please click here.

 

RELATED ARTICLES

3 key risks: banks are too big to behave badly

The sorry tale of our big banks

The outlook for Australian banks

banner

Most viewed in recent weeks

10 reasons wealthy homeowners shouldn't receive welfare

The RBA Governor says rising house prices are due to "the design of our taxation and social security systems". The OECD says "the prolonged boom in house prices has inflated the wealth of many pensioners without impacting their pension eligibility." What's your view?

Three all-time best tables for every adviser and investor

It's a remarkable statistic. In any year since 1875, if you had invested in the Australian stock index, turned away and come back eight years later, your average return would be 120% with no negative periods.

The looming excess of housing and why prices will fall

Never stand between Australian households and an uncapped government programme with $3 billion in ‘free money’ to build or renovate their homes. But excess supply is coming with an absence of net migration.

Five stocks that have worked well in our portfolios

Picking macro trends is difficult. What may seem logical and compelling one minute may completely change a few months later. There are better rewards from focussing on identifying the best companies at good prices.

Let's make this clear again ... franking credits are fair

Critics of franking credits are missing the main point. The taxable income of shareholders/taxpayers must also include the company tax previously paid to the ATO before the dividend was distributed. It is fair.

Survey responses on pension eligibility for wealthy homeowners

The survey drew a fantastic 2,000 responses with over 1,000 comments and polar opposite views on what is good policy. Do most people believe the home should be in the age pension asset test, and what do they say?

Latest Updates

Investment strategies

Joe Hockey on the big investment influences on Australia

Former Treasurer Joe Hockey became Australia's Ambassador to the US and he now runs an office in Washington, giving him a unique perspective on geopolitical issues. They have never been so important for investors.

Investment strategies

The tipping point for investing in decarbonisation

Throughout time, transformative technology has changed the course of human history, but it is easy to be lulled into believing new technology will also transform investment returns. Where's the tipping point?

Exchange traded products

The options to gain equity exposure with less risk

Equity investing pays off over long terms but comes with risks in the short term that many people cannot tolerate, especially retirees preserving capital. There are ways to invest in stocks with little downside.

Exchange traded products

8 ways LIC bonus options can benefit investors

Bonus options issued by Listed Investment Companies (LICs) deliver many advantages but there is a potential dilutionary impact if options are exercised well below the share price. This must be factored in.

Retirement

Survey responses on pension eligibility for wealthy homeowners

The survey drew a fantastic 2,000 responses with over 1,000 comments and polar opposite views on what is good policy. Do most people believe the home should be in the age pension asset test, and what do they say?

Investment strategies

Three demographic themes shaping investments for the future

Focussing on companies that will benefit from slow moving, long duration and highly predictable demographic trends can help investors predict future opportunities. Three main themes stand out.

Fixed interest

It's not high return/risk equities versus low return/risk bonds

High-yield bonds carry more risk than investment grade but they offer higher income returns. An allocation to high-yield bonds in a portfolio - alongside equities and other bonds – is worth considering.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.