1 October 2019 “The Wide Angle” – credit views with an edge

Large European banks should hold their ground against

fintechs
Large European butshould
banks only with
holddeeper legacy cost cuts
their ground
against fintechs but only with deeper legacy cost cuts

In the digital age, the image of a bank increasingly conjures up an icon on a

phone screen or a website. Not a temple-like high-street branch. It won’t be
long before spending one’s lunch break shuffling to a bank branch will have the Author1
same scarcity value as taking the car to a drive-in cinema.
Sam Theodore
The European banking industry has made significant efforts to adjust to the +44 776 932 1043
digital age and meet customer expectations, albeit with uneven results. All the s.theodore@scopeinsights.com
same, it is a space being challenged by fintechs and neobanks (see list of
selected neobanks in Appendix), with noisier drumbeats from big tech. Looking
at what is going in China, Southeast Asia, India, Africa, Latin America and also
to some extent the US – it would be easy to conclude that traditional banks in
Europe are likely to be increasingly out-gunned by the new entrants. Especially
since for too many European banks the ability to improve efficiency in the Media
digital age through painful but necessary adjustments appears limited. André Fischer
This, however, would be the wrong conclusion: Europe’s financial sector is not +49 30 27891 147
the fintechs’ to win; it is the banks’ to lose, and as a sector they are not likely to a.fischer@scopegroup.com
do so – although many individual banks may not exist in their present form in
five years’ time. Different from the dynamics in other parts of the world, the
fintech/neobank challenge remains more marginal for most of the European
incumbents, many of which in fact view it as a new opportunity. With the
condition of course that banks are able to speedily adjust their business
models, cultures, and cost structures to the digital age to meet changing
customer behaviour. Which is something that not all banks will be able to do.

Fintech market share grows fastest in under-banked regions: payments

and financial inclusion
Against the backdrop of fast digital advances opening new avenue for finance,
the key two drivers for fintech growth have been related to payments and
financial inclusion. They have both been present primarily in emerging markets, Scope Insights
where traditional banks have not played the same central role in the economy
as in developed markets. Consequently, the gap in demand for payments and Suite 204
financial services from an under-banked population has been filled by non- 2 Angel Square
bank entrants. UK-London EC1V 1NY

This has been the case in China, where the payment system is almost Phone +44 20 3457 0444
exclusively run by Ant Financial’s Alipay and Tencent’s WeChatPay – each
with roughly one billion active users (most of them in large cities). These two Scope Group
forms of payments are followed by cash and as a distant third by debit and
Lennéstraße 5
credit cards. Piggybacking on the mobile payments business, both fintech
giants have been offering savings, wealth management, loans, and insurance 10785 Berlin
to individuals and SMEs. It is unlikely that the traditional banks will be able to Phone +49 30 27891 0
disrupt the entrenched market positions of Ant Financial and Tencent. What is Fax +49 30 27891 100
more likely, and indeed happening, is that the two Chinese fintechs will
successfully spread their wings into other countries, especially emerging www.scopegroup.com
markets.
Bloomberg: SCOP
In Kenya, financial penetration jumped from 27% in 2007 to 77% in 2017. This
was not so much the result of traditional banks pushing for market share. It was
mostly the consequence of the growth of mobile payment systems, primarily M-
Pesa (established by Vodafone’s local subsidiary), adopted by a largely un-
This report is published by Scope
banked population. The fintech has been expanding successfully, with similar Insights, a Scope Group
strong results, in other sub-Saharan African countries. subsidiary which is separate from
Scope Ratings. The content is an
independent view not related to
Scope’s credit ratings.
1 Alvaro Dominguez contributed to this report.

1 October 2019 1/5

 Large European banks should hold their ground against
fintechs but only with deeper legacy cost cuts

In Nigeria, where half of the population lacks access to financial services, MTN, a large local mobile operator with 163
million users, is aiming to replicate M-Pesa’s business strategy.

Latin America, another region with relatively low banking penetration, offers financial-services opportunities to new
entrants. Mercado Libre, a large e-commerce company, is successfully growing its mobile payments and financial
services business to the un-banked. With over 12 million customers, Brazil’s Nubank is one of the world’s largest
neobanks.

The US: a highly developed market with a significant under-banked segment

According to the FDIC, a quarter of US households (33 million) are either un-banked or under-banked, making no or
little use of existing financial products. Unlike their European counterparts, US banks, historically more focused on
shareholder value and less on broad financial-inclusion criteria, have been able to refuse customers who do not meet
minimum expected profitability thresholds. According to the FDIC, the two main reasons for households not having a
bank account are (i) not having enough money to keep in the bank (53%) and (ii) not trusting banks (30%).

In recent years, serving the under-banked has been viewed as an opportunity for US fintechs and neobanks, which
could operate on a lower-cost base than traditional banks. Making full use of technology and lacking the legacy cost
burden of physical branches and back offices, the new players have been able to offer products and services that
would be economically less viable for traditional banks, such as payday loans at more affordable rates, savings, and
personal financial management (PFM) services.

In general, the large banking groups, which have massive IT budgets annually (ca. USD 10bn for each of the largest
groups), are finding it easier to compete with fintechs and neobanks and access population segments aimed at
financial inclusion without incurring losses. This push includes establishing low-cost neobanks with a different brand
to compete with fintechs (e.g. Marcus by Goldman Sachs, Finn by JP Morgan Chase, or Greenhouse by Wells
Fargo). But many second-tier traditional banks are finding it more difficult to keep the same pace.

Similar to Europe and other markets with developed financial systems, however, the financial ecosystem is changing
fast through the adoption of open API platforms, cloud storage for data, artificial intelligence usage, and blockchain
transactions.

In Europe, banks should continue to dominate the financial sector …

In Europe, the payment system – for both individuals and businesses – goes almost entirely through the banking
system, unlike many developing markets. European banks also hold a far larger market share of loan and savings
intermediation than their US counterparts (ca. 80% vs. ca. 30%). Based on the universal bank business model they
have pursued – a consequence of a different regulatory structure to the US and a different history – banking groups in
many European countries have been providing a full range of financial services, including wealth management,
insurance, and other non-bank services.

Equally, the proportion of the banked population is very high –not far from 100% in Western Europe. Lack of financial
inclusion is also less of an issue (though it remains more of a problem in Eastern Europe).

On the one hand, the European banking sector remains in pole position to avoid outside disruption on a mass scale.
On the other hand, its Achilles’ heel remains its high and relatively rigid cost structure, which with the fast adoption of
mobile banking becomes a critical threat.

Europe is fast becoming a vibrant ground for the growth of financial technology, especially in cities like London, Berlin,
Paris, Amsterdam, or Stockholm. Neobanks like Revolut, N26, Monzo, or Starling are becoming better adopted, with
the number of clients climbing. More than a third of all European neobanks and fintechs are UK-based, with Germany
coming second.

Nevertheless, profitability for most of these new players is still not proven, and this detracts from full credibility to their
business model. Their market position compared to the incumbent banks is also very marginal.

In general, for these reasons many of the large European banks have viewed fintech penetration as an opportunity
more than a real challenge. Inability to develop credible digital strategies, platforms and product offers remains a clear

1 October 2019 2/5

 Large European banks should hold their ground against
fintechs but only with deeper legacy cost cuts

and present danger for the banking sector, but many have made significant progress. Buying successful fintechs
which can fill specific digital gaps remains a valid strategy for the banks, one which will very likely continue.

Overall, banks’ image with customers remains positive across Europe (an improvement from the post-crisis years).
According to a recent Mastercard survey, 63% of banking apps used by European consumers are from traditional
banks – vs. 26% from social media and 20% from digital-only banks. As long as customers do not become
dissatisfied with the mobile offering of their bank, they will probably find no reason to switch to other providers – banks
or non-banks.

Nevertheless, a recent BI Intelligence UK survey revealed that for 87% of bank customers mobile devices are the
main banking channel they use, and for 68% a sub-par mobile experience would be the main reason for switching
banks. There is no reason to believe that elsewhere in Europe bank customer focus will evolve differently, especially
with the increasing reach of the younger generations.

This is also true with respect to the supposed threat coming from big tech firms. While a couple of years ago the
assumption was that GAFA companies (Google, Amazon, Facebook, Apple) had much stronger brands more trusted
by consumers than banking brands, this is no longer the case, at least not to the same extent – notably for Facebook.
People will continue to use big tech companies for their technology, e-commerce, knowledge and social-media needs,
but not many will hand in their financial wealth and needs to them.

Besides, the current regulatory dynamics in Europe (and elsewhere) are not moving in the direction of encouraging
more GAFA penetration – especially in financial services. It is very likely that the European Commission’s growing
antitrust focus, and the openly negative view of Facebook’s Libra project for a global virtual currency to compete
against traditional fiat currencies, will not make it easy for GAFA to make significant inroads in Europe’s financial
industry.

… but the emerging ecosystem will be threatening for incumbents unless they cut further their legacy costs
It bears repeating this: in Europe the incumbent banks can remain in the driving seat, but only to the extent that they
are able to adjust to the evolving digital requirements of individual and business customers. This is still not within
reach for all institutions, especially the smaller ones with fewer resources for massive IT investment, a more rigid cost
structure, and less of an ability to diversify revenue streams. Traditional second-tier branch-based retail banks heavily
dependent on lending-based revenue generation fit this definition.

New regulations across Europe, notably the revised Payment Services Directive (PSD2), are pushing banks to move
to open APIs and to a higher degree of transparency in their customers’ financial needs (with prior customer
agreement and relying on secure customer authentication). Some of the more advanced players, like ING, BBVA and
some of the Nordic banking groups, are creating platforms that they are opening to third-parties (fintechs, neobanks,
other banks) which can bring their own clients and services – while the host bank covers compliance needs, such as
KYC.

This business, known as banking-as-a-service (BaaS), is taking off in the US even in the absence of a PSD2
equivalent (see Appendix). And it should make traditional bank M&A (especially cross-border) even more obsolete:
why buy or merge with a cost-heavy legacy bank when clients can be secured far more efficiently indirectly via open
platforms?

In fact, building a digital offering and infrastructure, essential as it is, is European banks’ second-most difficult
challenge. The first is and will be for some time cutting legacy costs – related to both branches and back offices.
Barring this, banks will remain burdened with high and gradually less productive overhead – made worse by sub-par
revenues driven by negative rates and other headwinds – and thus in a less enviable competitive position vis-à-vis
fintechs and the nimbler banks across the system.

Banks are fully aware of this challenge. Branch networks are being cut and will continue to be so – in the UK (the
sector’s branch network has shrunk by one third in the last five years), Netherlands, Nordic region, France, Germany,
etc. Back-office over-capacity is being reduced. But the pace of cost cuts is still far too slow in too many countries,
challenged by prevailing social and political constraints.

While spending the lunch break at the branch is indeed becoming a mercifully rare experience, the high-street bank
branch landscape is not yet going the drive-in cinema route.

1 October 2019 3/5

 Large European banks should hold their ground against
fintechs but only with deeper legacy cost cuts

Appendix:

Selected neobanks around the world

How Banking-as-a-Service (BaaS) works

1) Fintech pays fee to access BaaS platform

3) Fintech uses APIs to build

new financial services
2) Financial institution acting solutions
as BaaS provider opens API
to fintech

1 October 2019 4/5

 Large European banks should hold their ground against
fintechs but only with deeper legacy cost cuts

Scope Insights GmbH

Lennéstraße 5
D-10785 Berlin

Phone +49 30 27891 0

Fax +49 30 27891 100

Disclaimer
© Scope Insights GmbH (‘’Scope Insights’’) produces independent and objective non-credit-rating-related research and opinions (‘’research and
opinions’’). Forward-looking statements are based on estimates, so the research and opinions do not constitute a factual claim; they merely
express an opinion, which may subsequently change and may then be reflected in an altered research or opinion. Consequently, Scope Insights
does not assume any liability for damage resulting from decisions taken based on any research and opinion it produces. The information contained
in the research and opinions is derived from sources that Scope Insights deems to be reliable; it has been compiled in good faith. Nevertheless,
Scope Insights cannot give any guarantee that the information used is correct, nor can assume any liability for the correctness, completeness,
timeliness or accuracy of the research and opinions.

The parties involved should only, if at all, regard such research and opinions as one out of many other factors in a possible investment decision; the
research and opinions cannot replace the parties’ own analyses and assessments. The research and opinions therefore only comprise the
expression of an opinion with respect to quality and do not constitute any statement as to whether the parties to an investment could generate any
income, recover any capital invested, or assume any specific liability risks. Scope Insights does not provide any financial, legal, tax, advisory or
consultancy services and does not give advice on structuring transactions, drafting or negotiating transaction documentation. Scope Insights does
not consent to being named an “expert” or any similar designation under any applicable securities laws or other regulatory guidance, rules or
recommendations. Scope Insight’s research and opinions are not a part of the credit analysis of Scope Ratings GmbH and do not represent the
rating methodology of Scope Ratings GmbH. The research and opinions do not represent or constitute a credit rating, rating driver, or rating action
and do not affect any of Scope’s credit ratings.

Managing Director: Florian Schoeller

Commercial Register: District Court Berlin-Charlottenburg HRB 202433 B

1 October 2019 5/5