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Payments in S.E. Asia a $1.5 trillion market: J.P. Morgan

But who will win this business? J.P. Morgan’s Harsh Modi argues in favor of incumbent banks.



Harsh Modi, J.P. Morgan

It’s a truism that for fintech companies, payments are the glue holding together an ecosystem – but that the real money is to be made in providing other services.

In some places, though, payments can be attractive as a business on its own merits. J.P. Morgan analysts say that Southeast Asia is such a place. But it may not be the fintechs who gain the lion’s share of this rapidly growing market.

In a report issued on February 18, Harsh Modi, Singapore-based co-head of financial research, and his colleagues at the bank say Southeast Asia’s addressable market for payments is $1.5 trillion, with banks, fintechs, telecom companies, and e-commerce companies all jostling for position.

Payments are being scaled up across a range of activities, including wealth management, digital assets, insurance, lending, and remittances – all accelerated in the past 12 months by consumer adoption of digital payments in the wake of the COVID-19 pandemic.

Banks’ massive deposit bases

Banks in Southeast Asia, like counterparts elsewhere, have benefitted from their ability to hoover up deposits, bolstered by trust, deposit insurance, and other regulation. They use these deposits to make loans of longer duration and at higher rates of interest.

“The be-all and end-all of any bank’s profitability is the deposit base,” Modi told DigFin. “It depends on depositors placing trust in the banks.” This is what then allows the banks entry into additional services, such as payments, money transfers, and selling savings and investment products.

Fintechs are not going to challenge banks at scale without accepting the same degree of regulation: ultimately it is the banking license that bestows this trust (for one thing, it comes with deposit insurance).

The average regional bank earns around 30 percent of revenues from non-interest income, such as payments, remittances, and other areas being attacked by fintechs. The region’s leading fintechs are scaling up in multiple markets, including GrabPay, Lazada wallet, ShopeePay and True Money.

Modi argues, however, that tech competitors are not going to unseat a local incumbent bank leader just by offering a better payments app. Foreign banks with smaller market share will face direct competition from fintech.

This goes for the incoming wave of virtual or neo-banks, with Singapore already having granted full digital banking licenses to SEA and to a Grab-Singtel joint venture.

“In Singapore, neobanks won’t take more than one to two percent of market share in the next three years,” Modi said. “Is that impacting the business of the top-three incumbent banks? I don’t see it making a dent.”

Addressable markets

That’s not to say there isn’t an opportunity for fintech, especially in Southeast Asia, where online payments are exploding. This is driven by the proliferation of internet services and smartphones, growth in the internet economy, expanding access to financial services, and better user experience.

In Indonesia, for example, J.P. Morgan calculates that third-party payments have risen by more than 1,000 percent in 2017-2019. That’s an astonishing figure. Growth has been robust, if somewhat more terrestrial, in Malaysia and Thailand, up to 120 percent. (Third-party payments represent the ecosystem, or infrastructure, that enables digital transactions such as e-commerce and selling financial products.)

Clearly growth numbers in the thousand-percents show it is coming off a low base. J.P. Morgan estimates third-party payment is still no more than 7 percent of retail sales in Malaysia and Thailand, as of 2019.

Indeed, in all three countries, the analysts reckon online payments are no more than 2 percent of the total addressable market (which includes credit cards, debit cards, and C2C transfers). Cash accounts for up to 80 percent of all retail transactions.

Looking at the total payment value in the six top economies of Southeast Asia, J.P. Morgan comes up with its $1.5 trillion estimate.

Incumbent advantages

Banking penetration is relatively low in Southeast Asia. Financial institutions have woken to the need to go after the vast segments they traditionally have not served. They are racing to digitize and either partner with or see off fintech challengers.

The leading banks in a given market, however, enjoy the luxury of low costs of funding.

As a rule of thumb, the higher the ratio of a bank’s current-account and savings-account deposits versus other types of deposits, the cheaper it is for banks to fund their operations.

This ratio is called a CASA ratio. Interest rates are usually very low on current and savings accounts (as opposed to time deposits or deposits for corporate clients). The less interest a bank has to pay a depositor, the bigger the spread when it lends that money to someone else.

Many Southeast Asian banks enjoy CASA ratios above 50 percent, meaning most of the deposits they rely on for funding their operations is very cheap. A few banks have CASA ratios above 60 percent, and three have ratios above 70 percent (Bank Mandiri, Bank of the Philippine Islands, and Kasikorn Bank).

Modi argues those CASA ratios are not at risk, at least not for the region’s leading incumbent banks.

Fintechs may have an advantage winning new markets – that is, the underserved. Banks may opt to go after these customers if their technology lets them scale to the point that the cost of customer servicing is not too onerous. But banks will be happy to leave these areas to fintech if it harms their profitability.

Fintech’s true impact

The fintech landscape is also fragmented. Take online payments: Indonesia, Malaysia, the Philippines and Thailand each have anywhere from 30 to 44 domestic e-money issuers jostling for users.

The biggest fintechs are branching out from payments into lending and other financial services. Grab Financial Group, OVO and Shopee all offer lending services.

So far they are providing short-term loans at higher interest rates, nearly 3 percent in some cases for a 12-month loan (and that’s charged monthly, so it will compound). Until these players improve their data-driven scoring processes, they must charge higher rates to compensate for riskier loans.

They could pose a risk to foreign banks with a small local presence. Foreigners tend to compete more on the basis of price, rather than local brand – which means they’re going to run headlong into fintechs.

Fintech companies really thrive when they can distribute high-margin products such as insurance. J.P. Morgan’s China internet team estimates a 90 percent gross profit margin for third-party distribution of financial products – a sales commission margin that should be valid in the Southeast Asian insurance market too.

Be it payments, insurance or other services, those fintechs that achieve the greatest success are more likely to be acquired by banks.

The entry of fintech is not creating a change in market leadership in Southeast Asia. “What it does is ensures that incumbents must match any innovative solution. Incumbents can no longer pursue rent-seeking. The entry of neobanks makes this a contestable market, which is good for consumers.”

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