Innocent Dutiro | Managing Director | Financial Services Lead | Accenture Africa | mail me |
For banks, disruption has become business as usual. Besides the ever-changing customer expectations, banks are under pressure to defend their market share against increased competition and the digitisation of the financial services landscape by neo-banks and FinTechs.
Banks are responding by including new customer experiences, upgrading their core banking systems, introducing cloud solutions, and implementing other new technology platform solutions while managing employee change fatigue.
At the cusp of another shift
Since 2020, governments and the broader financial systems have needed drastic measures to avoid the collapse of the global economy.
To kickstart the economic engines of the key international players, many central banks, including the South African Reserve Bank (SARB), focused on slashing interest rates to historic lows.
Although successful, the result was inevitably compounded by the additional liquidity (stimulus cheques) created by large global economies and further multiplied by the economic impact of the Russo-Ukraine War. Global economies are now battling a combination of demand and supply-led inflation.
The US has seen inflation exceed 4% for more than two months for the first time in 30 years. South Africa’s inflation rate has also broken the 6% barrier for the first time since 2016, reaching 7.5% as of September 2022, a 30% increase from 2021.
In response to inflationary fears, interest rate policies are being reversed with sudden increases. US interest rates are rising from nearly 0% to 2.5%, whilst South Africa’s interest rate hikes are returning to pre-COVID-19 levels, with 2022 already seeing an increase of 250 basis points (see Figure 1).
In the short term, local banks will welcome the rising interest rate environment as they benefit from the initial increase in interest-generated revenues from existing loans and advances. The unique circumstances surrounding the recent sharp interest rate hike and existing market conditions may swiftly become a crisis for the banks, with implications on both sides of their balance sheets.
South African salaries are stretched
From a lending point of view, South Africans were already over-indebted, with household debt above 65% since 2006.
The combination of the increasing inflation and interest rate, a weak exchange rate, ongoing load-shedding issues, the rising cost of fuel and high food prices are all resulting in immense pressure on the disposable incomes of South Africans.
According to the July 2022 BankservAfrica Take-home Pay Index (BTPI), the real take-home income saw a year-on-year decrease of 7.8%, and increased lending rates will likely begin to put further pressure on households. Therefore, the repayments and defaults will soon offset the initial interest income gains the banks experienced.
Compounding this situation is the increased interest rates’ impact on the potential ‘hot money’ or ‘lazy deposits’ currently sitting in banks. ‘Hot money’ is classified as funds sitting in current accounts earning little or no interest, which can be moved at short notice to interest baring investment accounts with the potential to impact the bank’s cost of funding.
In the US, ‘hot money’ is expected to significantly impact banks, with up to ±28% of deposits sitting in non-interest-bearing accounts, especially coming out of the historically low-rate environment. In South Africa, the situation is unlikely to be as drastic, with proportionally fewer funds sitting in current accounts (i.e., approx. 24%) and the fact that consumers were not faced with decisions based around a near 0% interest rate environment.
However, local banks should brace for margin pressures from both sides of their balance sheet and must be diligent in finding the right balance. Somewhere between recognising what is and isn’t in the bank’s control, banks will need to find ways to reward both borrowers and depositors whilst managing the risks ahead.
In the short term, this will require banks to:
- Manage risk: this means going ‘back to the basics. But basics are backed with large data sets and advanced analytics. Data and AI can be used to anticipate those likely to default. Therefore, default prevention, debt collection and credit recovery management should be human + machine enabled. It will result in innovative digital capabilities that empower highly skilled credit and collections specialists to minimise potential risk.
- Reward loyalty: The development of data-driven models or AI tools can also provide insights on those customers who have ‘hot money’ and calculate the financial impact should the deposits be moved in search of better returns at another bank. These insights should be leveraged to launch targeted and personalised offers to show commitment to a customer’s best interests by offering to help move their funds to interest-bearing products. Although this may seem counter-intuitive from a revenue perspective, it keeps the funds in-house whilst gaining relational capital with clients.
- Partner well: As rates continue rising, FinTechs funded by hot money could be under pressure or find themselves strapped as lending takes a turn. It could be a rare opportunity for banks to partner with the best-fit Fintechs to balance their portfolios. Whether it’s to gain access to new depositor markets or to get a foothold into underserved borrower segments, as FinTech valuations come down to earth, there will be M&A opportunities to bring on next-generation talent whilst expanding operations.
- Revive branch: For customers, a physical connection to their bank is still appreciated, especially in a country such as South Africa, which is cash-heavy for most of the population. Reviving the use of branches and the people in them brings soul to the entity. It provides the opportunity to show customers that a team of professionals cares for their money and financial well-being. Easy access and that personal touch will make customers feel their money is secure, which is vital in volatile times.
New areas of play
Although it is an area of caution for banks, momentum is building behind sustainable finance. In the years to come, regulatory developments and public incentives will likely hike demand for sustainable lending as banking customers become subject to increasingly strict industry-specific ESG-related regulations.
The banks that develop deep ESG knowledge and skills in their lending practices will thrive in the sustainable lending market while opening another interest income avenue.
Furthermore, in this new phase of the internet, the user will experience inhabiting a digital world just like in the real world. People will transact or own digital assets for which they need financial services. It holds enormous potential for banks to participate in the metaverse economy and have product and service innovations such as digital deposits or loans.
More tangibly, the metaverse can infuse humanity into banking to create memorable experiences and restore the dialogues lost in functionally correct but emotionally devoid digital channels.
Lastly, balancing the bank’s interests with customers’ needs is vital. Banks should keep in mind that as they pursue the monetary upside in the short run, they can use this moment to build trust and loyalty for long-term value.