Discovery Bank, TymeBank and Bank Zero must overcome a bleak history in a financial sector littered with failures

This column was first published in Business Day

I seldom encounter anyone who has a positive word to say about their banks. That’s why it is easy to believe that the market is ripe for competition. With the entry of several new banks — Discovery Bank, TymeBank and Bank Zero — on the horizon, one can imagine they will sweep into the market to solve the frustrations of the typical bank customer.

But it is going to be a tough battle. Any new bank faces two major problems: customers stick to the existing banks; and being a profitable bank is not as easy as keeping customers happy.

The history of challenger banks in SA illustrates the tribulations. While all three of the new challengers have emphasised that they will be branchless and digitally driven, this is not a new pitch. One only has to think back to icanonline, a joint venture between Mweb and BOE, and 20twenty, which was backed by Saambou, both of which entered the market in the early 2000s. By the middle of that decade they were gone, despite rave reviews from customers.

They were eventually absorbed into the larger banks after failing to survive their partners’ own troubles and a recalcitrant marketplace that failed to deliver the growth rates they had hoped for.

In the decade after, several attempts were made by banks working with cellphone companies, such as MTN Go Banking (with Standard Bank) and Vodacom’s MPesa (with Nedbank) to develop mobile-based banking services. None have lasted, with millions in development and setup costs wasted.

Outside the digital arena, several other challengers of the late 1990s that collectively formed the second tier of the banking market also failed in the early 2000s, unable to convince customers that they were a safe place for deposits.

This is a rather bleak history that the new challengers must overcome.

There is only one exception to the dour fortunes of new banking entrants in the past two decades. Capitec has managed to build a substantial and profitable bank, initially by forging into unsecured lending and then evolving into a broader retail bank with a large deposit book. It is now going into business banking and some asset-based financing, including home loans, with the acquisition of Mercantile Bank. It has done so not by foregrounding its digital credentials, but by the old-fashioned banking approach of managing risk better than the competitors.

So far the pitch being made by new entrants sounds closer to those of the digital and mobile-led failures of the 2000s. Could this time be different?

What does stand out is that all three challengers are standalone and complete operations. They have their own banking licences and do not have to manage conflict-ridden relationships with banking partners. Certainly, that conflict was problematic for icanonline and 20twenty, as well as the banking-cellphone ventures.

But, if we peer beyond the conflicts, there were deeper problems. What made 20twenty unusual was that it built a book of loans to its mid-market customers, though I hear the loan book had sky-high non-performing loan levels. The cellphone-based operations just couldn’t get their customers to shift behaviour into transacting with each other through their phones.

If anything, history provides one clear lesson: it is not the interface that a bank develops with its customers that matters. Rather it is the old-fashioned issues that face any bank: operating at as low a cost as possible, accessing cheap funding, and earning as high as possible a return on that funding, all while keeping an extremely tight hand on risk.

Bank reporting season kicks off this week with the annual results of Standard Bank on Thursday. Analysts will focus on return on equity, which shows how profitable banks have been with their shareholders’ capital; they will look at cost-to-income ratios, which show how efficient banks have been in generating income relative to the cost of running the bank; they will look at net-interest margins, which shows the difference between what the bank is paying for its funding and what it earns from its loans; and examine non-performing loans, which show how well a bank is managing its credit risks.

These same metrics will be critical to the chances of the challenger banks.

So far, only Discovery Bank enters the market with an entrenched market position. Its credit card book consists of 230,000 clients that form the base of the new bank. It also has 1.6-million Vitality members it can mine with the promise of more Vitality points.

TymeBank has significant experience in the market having quietly worked on cellphone-based banking for the past decade, most recently as a subsidiary of Commonwealth Bank of Australia.

Discovery Bank is sitting on R3.8bn in equity and TymeBank on R1.4bn, according to returns to the Reserve Bank. So far, neither has any material deposits or traditional banking assets.

Both will have to work hard to deliver to their shareholders, which means raising deposits fast and then building the asset side of the balance sheet to deliver a healthy yield and doing it at minimal cost. It will be a tough slog.