OT how about that?
Bank stocks face net upheaval
By Ivor Ries
Bullish investors drove Australian bank shares to record
highs this week, valuing the country's eight largest banks
at $120 billion. For the most part, the blanket buying of
bank shares was based on blissful ignorance of the
technology shock that is about to shake the banking
industry to its roots.
That shock is, of course, internet banking. Most investors
haven't thought about it yet, but they should watch out.
Once netbanking takes hold on the general population,
bank shares will gyrate with investors' perceptions of the
success or otherwise of individual online banking
products. Stocks of banks that miss the netbanking bus,
or find themselves at the end of a technological blind
alley, will be punished severely.
Internet banking isn't new. It started in America in 1995
and in Australia, via the Commonwealth Bank, in 1997.
What is new is the explosive growth of netbanking
connections over the past six months. Bankers believe
that in a few years, between 25 and 40 per cent of
Australians (the world's fastest adopters of new
technologies) will be conducting most of their daily
banking business over the internet.
For a taste of what's about to hit Australia, look at a few
developments in the US. In December last year the
number of Americans banking over the internet hit 7
million, growing at an average rate of 640,000 a quarter
in the previous five quarters.
The explosion of netbanking in America in late 1998 was
especially remarkable given that at that time less than 30
per cent of the top 100 banks offered a netbanking
service. Within six months, however, more than 80 per
cent of America's 100 biggest banks will offer
netbanking, and the number of new netbanking
connections each quarter is expected to more than
double.
The fastest-growing banks in America today are internet
banks: Telebanc Financial Corp and Net.B@nk. These
two pioneers are seeing asset growth of 20 to 30 per
cent a quarter and alarming their conventional
competitors by charging no fees on most transactions and
paying deposit interest rates that are 15 to 20 per cent
higher than those of other banks. Net.B@nk did not exist
two years ago, yet it wrote $100 million in mortgages in
the past six months.
Investors have made a killing. Telebanc shares have risen
1,400 per cent since last August's low; Net.B@nk's by
1,080 per cent over the same period. Shares of most big
US banks have also risen strongly -- 20 to 30 per cent
on average -- but already some American analysts are
warning investors to steer clear of banks that don't have a
clear netbanking strategy.
Until recently, most US bankers put Telebanc and
Net.B@nk in the same box as home loan originators:
single-product discounters which didn't get mainstream
bank customers to switch their primary banking
relationship. But now the awful reality is sinking in: most
people switching to the internet banks are taking their
primary banking relationship with them.
Like most technology shocks, internet banking trashes
the ground rules. Although the objective of the game
stays the same -- making a profit from delivering financial
services -- the old rule book is almost useless. In
Australia, the most advanced netbanking player is
Commonwealth Bank boss David Murray. Murray
pushed the netbanking button 15 months ago, and today
the CBA has 120,000 customers -- growing at more
than 10 per cent a month -- conducting banking or
stockbroking business over the internet. On current
growth rates, netbanking and netbroking will be a hugely
profitable business for the CBA within two or three
years.
Of course, Murray isn't alone. Westpac's David Morgan,
ANZ's John McFarlane, St George's Ed O'Neill and
National Australia Bank's Frank Cicutto (who will be
launching his service in a few weeks) are all dancing the
netbanking tango in one way or another, and for a variety
of reasons. But the main reason is the fear of losing their
most valuable clients. Internet usage is concentrated in
the young, the highly educated and the wealthy, the
groups that (with the exception of wealthy retirees)
provide the bulk of retail bank profits. Bankers often say
that 20 per cent of their clients deliver 80 per cent of their
profits. The overlap between potential netbanking users
and the banks' most treasured clients is about 80 to 90
per cent. So the bank that makes a mess of its
netbanking strategy is at grave risk of driving its most
profitable clients into the arms of a competitor.
The banks most at risk will be those whose directors
view netbanking as just another arm of their direct
distribution system, such as telephone or branch banking.
In reality, it should be regarded as a totally new business.
In traditional direct distribution systems, it's hard for any
bank to obtain a big competitive advantage. The basic
costs of doing business through a branch or a telephone
call centre are widely known and benchmarked. As
cost-to-income ratios for traditional banking are hard to
move, rarely can one of the majors afford to undercut the
others by aggressive discounting. It's the same with the
product range. Most major banks offer products that are
almost indistinguishable from those of their competitors,
and where there are big differences it's difficult for
consumers to make comparisons.
So in traditional banking, sameness of product delivery
costs and sameness of product features (or at least lack
of comparability) lead to close pricing and little incentive
for consumers to switch. It's not surprising that less than
5 per cent of customers switch their main bank each
year. In internet banking, none of those rules apply.
There can be huge differences in service delivery costs,
and because there is no industry standard netbanking
software platform there will -- at least initially -- be a
considerable gap between features and service quality
from various banks.
In short, in netbanking it's possible for the best operator
to have a massive competitive advantage in cost, product
features and service quality over the rest of the market.
The internet also empowers consumers. By allowing them
to make direct product comparisons with a few clicks of
the mouse -- and to switch funds from one bank to
another in a split second -- netbanking revolutionises the
bank-customer relationship. Customer loyalty becomes a
thing of the past. Get ready for banks to begin using
buzzwords like "churn rates", a reference to the number
of customers who switch to rival banks each month. In
this brave new world, pricing, service standards and
brand strength are the only weapons a bank has with
which to defend its turf.
While customer retention is a nightmare in the netbanking
world, the beauty is that those who get it right will enjoy
profit margins unseen since the Spaniards liberated South
America of its gold. That's because the internet allows
banks to deliver some services -- such as money
transfers between accounts -- at a 10th of the price of
the next cheapest delivery mechanism (usually telephone
banking). Netbanking is that much cheaper because the
customer provides the labour that the bank has to pay for
on other delivery systems. But although service delivery
can be as cheap as chips, Australian banks charge
netbanking customers as if they were using a more
expensive system. For example, a standard telephone
banking transfer of funds between accounts costs about
40¢ to 60¢ (depending on the bank). Yet while banks all
charge the same fee for the same transaction done over
the internet, the cost of completing the transaction is
probably less than 4¢.
So the gross profit margin on basic netbanking services
-- once they are fully established -- will be around 90 per
cent. How long that can last is anyone's guess. But unless
a serious new competitor enters the market, it's hard to
see the big four starting a netbanking discounting war.
Although netbanking sounds like a way to combine
perpetual motion with double-digit profit rises, it's not.
Banks that use the wrong technology will see their profits
consumed providing salaries for hundreds of netbanking
help desk employees. When a bank's software begins
trashing the hard drives of customer computers -- and
that could happen -- the bank's board will need a whole
box of hara-kiri swords.
Technology isn't the only big issue facing bank directors.
The other is what to do about loss-making or low-margin
clients, who make up 60 to 70 per cent of a bank's
customer base, most of whom insist on using bank
branches and face-to-face transactions with tellers.
Last year, Australia's big five banks spent $2.2 billion on
branches and ancillary costs and $8.8 billion on
employees. Once the most profitable 20 to 30 per cent
of bank customers have switched to netbanking, it will be
hard to justify spending money on branches and tellers
used primarily by the low-rent crowd.
Do you know anyone who wants to buy 4,000 former
bank branches? Their dreams may be about to come
true.
(The author owns NAB shares.)
afr.com.au
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