COVID-19 has changed the world. In the last few months, we have seen companies closed doors but we also have seen new adoption of services all around the world. Share prices for Tesla (TSLA), SEA Group (SEA), Zoom (ZM) and many others have thrived during this period. However, there is one industry who’s share price still remain depressed. It is the banking industry.
Today, I want to share why investing in the banking industry (DBS/OCBC/UOB) is not longer suitable for your retirement.
Moss Piglet’s Note: Today we are glad to have Chengkok from Wealthdojo to share his latest article with us.
Let’s start with the most basic and that is the role of the bank. I know many retail investors have a very vague idea of the role of a bank and how it makes money.
Banks (in general) tries to allocate funds efficiently from savers to borrowers. Think about it this way, there is a group of people who don’t need the money currently and there is a group of people who need it immediately. The bank brings these 2 groups of people (only their money) together. They charge the borrowers and they reward the savers.
The more money they have from savers, the more money they can loan out to borrows.
They generally make money in three ways: interest on loans, interchange (not going into detail), and fees.
Interest on Loans: Net Interest Margin
People like you and me put our deposits into banks. The banks use these deposits (up to a given ratio as stipulated by the central bank) to provide loans (home, auto, student, etc) for other customers. The bank charges a certain interest percentage to these customers. This money earned is the revenue for the banks.
At the same time, some of revenue is given back to the depositors as interest in their saving/checking account. This is an expense for the bank.
When we take the loan revenue minus the interest expenses, we get the net interest margin. To put it in another way, the difference between what the bank earns on its’ loan minus what they need to give back to their customers as interest is net interest margin.
For a bank to be profitable, we would want to find out that they have a positive net interest margin.
Most people are familiar with credit card fees. This is the part that annoys many customers. Banks find ways in which to charge their customers all sorts of fees. It could be credit card annual fee, late payment fees, early repayment fee, admin fee, monthly service fees, minimum deposit limits, withdrawal penalties, ATM fees, overdraft fees, and foreign transaction fees etc (you get the point). Banks usually have a long list of fees and you can check out on any of their websites.
Though annoying to the customers, it forms part of the bank’s revenue.
Ever wondered how we stand compared all over the world?
According to Global Finance 2017, we were ranked 11,13,14 for the safest banks in the world. I believe that this is strongly due to our position as a reliable financial hub. The chances of default for the Singapore government and the local banks are small. In Asia, we bagged the top spot for all 3 banks.
Moss Piglet’s Note: Based on Global Finance’s 2019 rankings released on Nov 2020, these 3 banks have dropped in global rankings to 15, 16 and 18. https://www.gfmag.com/magazine/november-2019/worlds-safest-banks-2019
Then why such a pessimistic view on the local banks?
Taking a look at a long-term trend for Net Interest Margin for Singapore is enough to show that it is on a sideways trend. This is not a cause for alarm. I believe that having a consistent spread is “healthy”. A sudden spike in either direction might not be beneficial to the depositors, the lenders and also the banks.
An example would be if Net Interest Margin spikes up, this could mean a few things.
- Loan interest increase, keeping depositors interest constant. This would mean that it is difficult to loan money in Singapore and might create a credit crunch. There might be lower investment activities in Singapore because of that.
- Depositors Interest decrease, keeping loan interest constant. This would mean that there is less money in banks to loan out. People will want to consume more because keeping in the bank gives less or no interest.
The above is only purely for discussion. My concern is the dependence of Net Interest Margin for the banks and also the upcoming low interest environment of the world.
Net Interest Income Forms ~60% of the bank’s revenue
Taking the 3 banks annual report, we can see that on average Net Interest Margin forms ~60% of their revenue. This is a given as their main business line is lending money. The challenge for banks comes due to the reduction of interest rates.
For example, Interest rates are priced based on SIBOR (Singapore Interbank Offered Rate). SIBOR is a floating rate used by banks for their mortgage packages sometimes SOR (Swap Offer Rate).
This chart also shows that SIBOR rates has been depressed and can remain depressed for very long.
As they can only charge these depressed rates, the other factor would be to increase the amount of loans that they can give out. Given the COVID-19, I don’t think the amount of loans given out will increase. This is because of the following reason.
- Banks might be even more conservative to issue out new loans. (remember we are a safe bank)
- Companies might also be cutting cost and may not want to expand.
Singapore forms ~50% of the loan books
Visually looking, Singapore forms majority of the revenue in 2019 for all 3 banks.
With GDP consistently hovering around 3% for the last 10 years, there is not much growth on the local shores. I feel that banks have to look outwards to be a regional or a global bank. To add oil into fire, COVID-19, shrank our GDP by 41.2% (https://www.ft.com/content/35acd3e5-864f-4086-ba88-6343c709a14d). We still do not know if this incident will be a one time off. However, the consistency of a 3% growth is worrying.
“The understanding of financial products among the new generation starts with an e-wallet, not a bank – Kartika Wirjoatmodjo, Mandiri Bank”
I believe the future of banking will start with an e-wallet. The market is being tested and being disrupted right now. Sitting in my phone, I already have a few e-wallets such as Grabpay. DBS/OCBC/UOB will have to be more competitive in the digital space.
In the past, I remember going to the bank to open an account. There were police officers patrolling and there seemed to be good looking people shaking hands with smiles. Now, to open an account, all it takes is for me to go online and open one. The fight to remain relevant is a tough one.
The competitors are no longer banks
The banks biggest competitors are no longer themselves. They are now the fintech companies. More and more companies are coming into the financial services spaces. MAS confirmed in 2019 that it will accept applications for five new digital banking licenses (https://thepaypers.com/payments-general/singapore-to-licence-neobanks-and-wholesale-banks–1241099). There might be new virtual wholesale banks. These includes Chinese Fintech Ant Financial, TikTok, and two Singapore-based internet service providers, Sea and Razer.
The road ahead will not be business as usual. I believe there will be experimentation, failing and raising above the occasion like we always have.
More and more companies will give banks a run on their money. Just take reference to Amazon. You would want to know that Amazon main business is not a bank. (https://fintechnews.ch/fintech/bank-of-amazon-is-disrupting-the-financial-landscape/21954/)
Closer back home, we have Grab.
These new challengers will come in quickly. For now, they are unlikely to be of significant relevance. This is because there are hefty capital requirements that is required. This will also slow down their ability to effectively compete with traditional lenders. However, I would not underestimate their ability to raise those funds in this environment.
DBS, OCBC and UOB has seen many good years over the last few decades. Moving forward, the low interest rate environment, the high concentration of local lending and also disruptive competitors will mean that the banking industry will become even more competitive.
Banks are a cash cow and will remain a cash cow in the next 5 years. I feel that the banks will continue to give strong dividends even in this crisis and the years to come. Dividend yield remains attractive and it is undervalued according to traditional valuation matrix. For example, DBS still have good valuation (http://yourwealthdojo.com/should-you-buy-dbs-group-holdings-ltd-sgx-d05-now/). Please do you own due diligence.
However, I question the ability of the banks to grow in Singapore and the future of it.
Disclaimer: I do not hold any shares in DBS/OCBC/UOB nor plan to initiate any positions anytime soon.
Moss Piglet’s Note:
Even before COVID-19, the financial services industry was evolving at a rapid pace. Changing consumer demand, heightened competition from incumbent banks and new entrants, and significant advances in technology are some of the driving factors.
Open banking in particular is transforming the banking experience. Digital transformation of banks has the potential to increase financial services access for more people, increasing consumer choice, widening the pool of potential customers for businesses, while improving efficiency and significantly reducing operational costs.
The global pandemic has accelerated this evolution and it has become clear that the digital transformation of banks is finally upon us. To me, it seems like DBS is at the forefront of this transition.
The writer Chengkok is a financial blogger from Wealthdojo He is a strong believer of the 6 Level Wealth Karate System. He is concerned that there are many opinionated articles online that give extreme advices without taking into consideration of your unique situation. Find out more here http://yourwealthdojo.com/wealth-management/.
You can check out my blog, where I write about financial topics. Also, feel free to join my Telegram (https://t.me/wealthdojo) Channel for a financial tip every day!