Consumers Are Turning Away From Traditional Banks

lucrative two trillion dollar market. All are nipping at the heels of the big traditional banks which were once the undisputed masters of payments. Their credit cards now face unprecedented rivalry, their profits are at risk, and Australia has become a key battleground. What does this mean for Australia's big banks? The trends after the pandemic inveins startling. It's very hard

now for the banks to reggae in the initiative. Here, let's bring in Matt Ingram, senior financial analyst with Bloomberg Intelligence in Sydney. Matt welcome, gooday, Tom, gooday, John Great to be on board. Matt Digital wallets have been around for years. Recently they've gone from being background noise to

serious contenders for Australian banks. And we had a tipping point for digital payments John, it's it's an exciting time for payments, Jack Baxter and I and Sydney have done a real deep dive and dive on these trends recently. And the pandemic was a game changer for payments in Australia, particularly for small business You may recall prior to lockdowns, many small businesses were cash only. You think your local

sushi shop, they wouldn't have accepted cards at all. Now most do either through a bank provided terminal or something like a square terminal. Now, behavior changed substantially across the retail space during the pandemic, and I think that trend is embedded now many more people are using while it's multiple times a day versus perhaps once a day for their banks app, and the virtually not visiting the branch

at all. I think that trend has tipped the balance away from banks and I'm not sure how they're going to regain the initiatives. So, Matt, can you provide some numbers what percentage of total consumer sales are now purchased using digital wallets like Apple Paying, Google Pay versus traditional credit cards. John the trends after the pandemic events startling wallets jumped from about three percent of retail sales and eighteen in Australia, and we think that's substantially higher again

in Obviously it's pretty popular for e commerce transactions. It's about of total. But I think the trend that worries banks is the jump from two percent of in store sales to eleven. Now that's the traditional domain of banks and credit card providers like Visa and MasterCard. C BA said that about It's wallet payments are made by tapping an Apple device, either a watch or a phone. That's an amazing competitive advantage for Apple given they had just

the market share of phones in Australia. Now, this suggests to me that there's still significant room for while it uptake to continue. Matt was the rise of digital payments inevitable given the Martrop technology the evolution of technology. Is there anything the banks could have done to prevent themselves from becoming so vulnerable? Well, thanks time. Look, it's probably unfair to say they are asleep at the wheel, but I think they were fighting a fire on multiple fronts.

They were not only focused with scaling down their branch networks. They initially were focused on ramping up a t m s, only to ramp down a t m S when they realize that ATMs are an expensive way of interacting with their customer. They were they were very much focused on increasing card transactions instead of cash transactions. The money they invested in getting out of branches and and doing some kind of transitional step could have been spent on going

in and being strong and leading digital. Look, that's what they could have done. They could have adopted the true digital technology, not just sort of transferring money online from one account to another, but actually facilitating digital payments like we're seeing from Square and other companies like that. So I think there's two sort of tail winds that are

going to continue this trend. The first is that android penetration is extremely low, and the second is that Australia, which is a fairly tech savvy market, is still lower in penetration than the US. So mat was this a case of consumers going into shops and rather than taking out their credit cards from their wallets, that just tap their phones to pay the sort of the pop survey that I've done around the office, and certainly my own

spending habits post pandemic. It's that and some I pay for the m R T in Singapore by tapping my phone. I buy sushi by tapping my phone, by a case of wine by tapping my phone. It's it's everything from a one dollar transaction to a five dollar transaction. And I think that's fairly typical of your your average smartphone user.

So can you talk us through the economics if customers pay using their digital wallets versus a credit card, a physical credit card, how would this impact the revenue for banks? There's two sides to that equation, John. We think the payments business in its entirety in Australia is about two point five billion dollars, or at least the retail point of sale payments business is about two point five billion dollars.

The cost of the tapping is about six million dollars a year, So the banks don't want your tapping your phone. The real rub, though, is that the banks are losing

ownership of their customers. Once upon a time, in the days of bricks and mortar, the relationship was fortified by bricks and mortar branches where you had to go into a branch to deposit your money, and the relationship was a very solid, very sticky one, and I think inadvertently what the banks have done is they've handed over ownership of that relationship to Google and Apple, and they've put Google and Apple in a position where they can be

disintermediated because the customer is no longer having a relationship with the bank, they're having it with the wallet provider. That that gets accentuated if the back end, if the pipes of the payment network also move away from traditional channels onto some form of blockchain functionality, and there are providers that are that are exploring that. Already, two pretty key examples I think that are exciting a lot of

payments practitioners. Shopify has already adopted a lightning functionality. So Shopify has got about two million customers globally. There be two b Payments can now be done over the blockchain virtually instantaneously at virtually no cost. That does give the functionality now for Shopify to bypass banks and card companies completely. Strike which is another another solution is also offering again payment channels that bypass bank networks completely. They're offering FEX products,

and efex is a hugely lucrative, very transparent business. And so those are two examples of where the banks have already lost the initiative and where this sort of reintermediation to become disintermediation of the banks could could eventually happen. Does it surprise you how quickly these new payment trends took off and how quickly they were accepted. I think, Look, I wouldn't call myself a visionary Tom, and so I think the wallet makes sense. It's extremely convenient, buy now,

pay later. I think it's extraordinary. It's it's created a seemingly a new market out of thin air younger borrowers. I think quite cynical of the big banks after the global financial crisis. I think they're very scared of credit cards. Matt, let's talk about b n P L or buy Now, Pay Later. Give us an idea as to how this fits into the broader matrix, and how these providers manage credit risk with regard to the consumer and the merchant, and how big a threat does buying LP leader posed

to banks. So just quickly to explain how it works, it's it's a service provided by the likes of of Cliner or or after Pay or ZIP, and it's actually a service provider to the retailer. So the payment occurs between the retailer and that provider. It's sort of something like four to six of the transaction value. That's versus about two percent for a credit card transaction. So the relationship there is between between the buying our pay later company and the merchant, and then the customer at the

other end pays the ticket price. It could be that it could be the markdown boxing Dale sale price. They don't wear any costs at all from the transaction. A key part of that buying our Pay later relationship is that they stipulate to the merchant that there's no pass on of the fee. That creates a sort of an arbitrage. They can charge what they want. They're not competing with

the two percent fee the credit card company's charge. Look, we did see a massive massive uptick in incredit issues across the sector last year from extre emily low levels, and certainly the credit quality is worse than your traditional sort of consumer finance providers, but they're still tweaking going

on the risk models. ZIP did a major overhaul of its its credit models last year, which did impact its growth in the second half of two but their their credits trending back towards about two percent of transaction volumes, and given the significant margins they're making their market making a six percent gross margin on that transaction, and the operating costs are extremely low so that they can afford

to take that two percent credit haircut. So the trillion dollar question, tom, is what happens when interest rates really bite. In terms of the product, it's it's a fairly different demographic as well. It's tends to be a younger demographic. They're using it as a savings plan. I can't buy my my new dress or my skateboard or my bicycle today,

I don't have the cash. So I'm going to spread that over three pay cycles of three fortnits and so it's I think seen as the savings planned by a lot of the users, and the company has said there has been no change to that trend. So look, I think it's naive to think that this industry will be immune from credit pressures as interest rates really start biting. But the business model, I think is resilient. I think the business model is getting a harder wrap than is

due based on your logic. Both buying our pay leader or be in p L, as well as the digital wallets really thrived during the pandemic. Now we're coming out of the pandemic. Do you think these trends will reverse. It's a huge question, John, not just for buying Our pay Later, but for wallets and e commerce generally. It's one thing when somebody's sitting at home eighteen hours a day, work, play, recreation in front of their computer in their living room.

I think something that gives a bit of comfort to buying our pay Later volumes is that they did stay very healthy in people went back to work last year and certainly the last six months I think would have given the providers some hope that the business is sustainable in environment where people aren't parked at their desks at home most of the time. The wallet trend off as convenience.

It puts all your cards in one place and and amazingly, I think the trend that happened over the pandemic as many retailers now only accept credit cards, where four years ago cash was preferred. So if you're in the habit of tapping your phone. Every retailer you walk in now is going to accept it. I think the only way banks arrest this trend is, as I said before, I think they need to embed some kind of NFC or

tapped to pay technology within their own ecosystem. When I look at where the banks have gone with this, all of the Australian banks have spent a good chunk of the last four years fighting with Apple and working away that they can actually be present on the Apple platform, and perhaps in hindsight, that energy would have been better spent having their own tap to pay per actionality in their own ecosystem. Matt, you're painting a picture of a

brave new world in digital commerce and digital finance. Where does cash stand in this scenario? Or you're describing Yeah, Tom, it's interesting. Um, I think most people are frustrated with cash. To be honest, If you if you're asked by your children to bring a gold coin donation for our for the Easter hat parade or or some kind of touch shop at lunchtime, it normally necessitates a race out to an a t M and then a trip to the

coffee shop to get some change. I think most people now are actually very short on cash, and I think that's here to stay. Matt, give us a glimpse into your crystal ball. What do you see five to ten years down the road the dynamic between the banks the digital payment systems. How does the interplay between them unfold? Yeah, thanks, Tom,

look at it. It's it's a good segue into something we haven't spent as much time talking about as we could have maybe, and that's that's the impact of the crypto on this on this theme, So where do I see things in five to ten years. I think Visa and master cards strangle hold on payment networks will be at least weakened. I think there's a there's a variety of different settlement methods available over the crypto block chains,

and I think those might eventually become the default. Our crypto analyst here in Sydney, Jamie Douglas Coots, certainly thinks that in the longer term, those those settlements over the blockchain networks are going to become fairly commonplace, and so that gives the opportunity for businesses for consumers to transact instantaneously at much lower cost. So that's number one. I think the pipes at the back of payments become far cheaper, far quicker, and operated outside the oligopoly of Visa and

master Card. The second thing I think is the horses bolted now and wallets are established. And I think wallets will continue to be the predominant way that people will pay for things, whether that's via your phone or your watch or whatever. But I think that the trend of people tapping plastic plastic cards is one that's going to going to decline further. I think deposit balances for banks,

particularly the cheap transaction deposits, are under threat globally. I think customers are becoming far more savvy, and they've got access to far more information than they would have had in our parents generation, and so customers know that they're getting a raw deal parking their deposit in a bank for no interest. They don't want to park all that

cash there, and neither does a small business. A small business, I think, is also probably more savvy in that respect, and so I think the deposit franchises the banks get eroded. What does that mean for the sector? Look, I think it means high funding costs on average. I think this access to extremely cheap funding, certainly for banks in developed markets is going to be something that's challenged, and so through the cycle, I think the only thing that happens

there is that banks margins get constrained. I think a bank business model is still something that's extremely sustainable. But but the wash up of that is that banks payments revenues get eaten. I think banks deposit franchises get cannibalized a little bit, and I think their their earnings that they can make on those deposit franchises get constrained, and overall, I think the profitability of the industry, the banking industry

certainly may be pressured. Man A lot of names stand to profit from digital payments, Apple, Google, Squares, Zip, Sharpify. Is there an easy way for investors to get exposure to the space? Look, digital payments is going through exciting times and we're quite excited with the with the positioning of that within Bloomberg Intelligence. We've created a digital payments basket over the last couple of years. That's a method for investors to get exposure to the largest and most

sensitive companies to digital payments globally. We offer a variety of solutions via our via our partners to invest in that theme. And it's something we're extremely excited about. Matt. Final question, The Aussie stock market is dominated by banks. If you look at the market cap, I think four of the biggest six belonging to the Big four Australian banks. Given all these challenges, do you think this will still be the case in five years from now? Yeah, Jee,

it's a good question, John. I think again, if I had a dollar for everyone, every time someone had called the end of the the oligopoly of the big four Australian banks and their dominance of the Australian stock market, again, I think I'd be I'd be retired on the beach. But look, I think they've still got a substantial economic mode. This sounds like I'm having a bet each way. I've spent the last twenty minutes talking about the threats to them,

but their economic mode is still huge. Their deposit franchises are significant. They may shrink, but they're clearly not going to go to zero. They've got a significant funding advantage on the back of the Australian government's very strong credit rating. Customers are fairly mature in the relationships that they have with them, and they're very sticky and at least for the next two to three years. Higher interest rates give them a massive lift in profitability and in profit so look,

their valuations held up well last year. They they outperformed a fairly week Australian market despite the market volatility, despite potential threats from our from appending recession as interest rates really buy it. And look, I think in the absence John, of a massive credit crunch that might be on the back of the rate hikes, and that's not our base case. That's very unlikely in our opinion. In the absence of a massive credit crunch, I think the outlook for Australian

banks remains very healthy. Mad and Grom Senior analyst with Bloomberg Intelligence. Matt some fascinating material and a compelling glimpse at the way technology is changing, how the way we buy sell and sharp. Thanks Tom's thanks John at certainly exciting times and I guess watch this space. I'm Tom Corbett, editor with Bloomberg Intelligence in Hong Kong, and I'm John Lee, and you've been listening to the Asia Centric podcast