Significant challenges ahead for Thailand banking sector: how to navigate through the pandemic storm
The COVID-19 outbreak will further impact Thai banks' profitability, bringing additional structural challenges to an already deteriorating market with intensified competition, commoditization of services, shrinkage of some fee revenues, and rise of non-performing loans (NPLs), according to management consultancy Roland Berger.
Increasingly challenging times ahead
The core revenue of banks, including interest income and fees income, has been on the decline especially from the second quarter of 2020 despite the growth of banking assets. Roland Berger estimates the total operating income to decline by 7% in 2020 compared to the previous year. In addition, NPLs are on an upward trend, reaching 3.2% in the second quarter of 2020, and are expected to continue increasing over the upcoming months especially after the relaxation of the Government's financial aids. Due to these uncertain and turbulent times, banks are in a cautionary mode and the cost of risk has been significantly increasing to cover for potential low quality and riskier loans. This is clearly shown by the increase in banks' H1 2020 loan impairments, which almost doubled (+80%) compared to H1 2019. Roland Berger expects NPL volume to continue growing towards the year-end and in 2021, with an increasing cost of risk strongly hitting the banks' bottom line.
In an updated study to one that was published in February 2020, Roland Berger estimates that the erosion of the Return on Equity (ROE) is expected to worsen by a further decline of 1.1% in 2020 and 1.3% in 2021 with the prolonged effects of the pandemic.
Impairments are likely to be ~1.2% of the total assets in 2020 compared to the average value of ~0.8% in the previous years.
Businesses and individuals are expected to be more conservative with their liquidity, growth investments and spending over the next years, posing a great challenge for banks in revenue generation. Existing rigid investment structures, in particular for digital transformation programs, along with the higher uncertainty and the overall deterioration of debt quality, will also directly impact the banks' bottom line.
On the bright side, COVID-19 has fostered a change in consumers' banking behaviors, paving the way for digital banking advancement. Due to countrywide lockdowns, a surge of online banking activities and transactions nearly doubled compared to the previous year. Roland Berger observed that in line with this trend, the number of bank branches in Thailand have also reduced 3.8% from 6,508 to 6,260 from December 2019 to September 2020, and this reduction is projected to continue beyond the pandemic. "These cost improvement initiatives are now even more crucial for banks, especially for institutions currently undergoing broad digital transformation programs. They will be able to capitalize even more on the change of mindset and habits of their customers, while opening avenues for further physical network optimization", says Mr. Philippe Chassat, Senior Partner at Roland Berger.
To tide through the pandemic, Roland Berger estimates that to maintain an average ROE of 8% over the next four years up to 2024, banks will need approximately THB 40-60 billion (USD 1.3-1.9 billion) of cumulative cost savings to cope with the impact of the pandemic. This value is in addition to the cumulative cost savings already estimated for the digital transformation journeys (THB 100 billion for the optimistic scenario where digital dividend is realized in the year 2023 and 2024 and THB 170-180 billion for the worst-case scenario without any significant future digital dividend realized).
Mr. Philippe Chassat cautions that these estimations assume a containment of the COVID-19 spread in the first half of 2021 and the continuation of the support from the Thai Government's financial aids until 2021.
Tightening the ship and steering through the storm
"In this rapidly changing environment further accelerated by the COVID-19, launching material tactical cost containment programs has to be paired with anticipating the behavioral shift of customers' channel and servicing preferences to ensure the success of the bank's long-term strategy," states Dr. Luca Turba, Principal at Roland Berger and co-author of the study.
In addition to launching bank-wide cost reduction programs such as Accelerated Zero-Based Budgeting (AZBB), Frugal IT or Procurement Excellence, banks must further accelerate the ongoing transition from physical to digital channels and rethink their overall physical network footprint and their servicing models.
Advanced data analytics tools such as the "RB Branch OptimizerTM" allow Banks to extract the maximum value from their physical network. Besides assessing normalized branches' performance and identifying consolidation potential, these tools offer banks the opportunity to define the optimal branch density and location to maximize profitability or revenue generation.
Along with the optimization of the physical distribution networks, banks should undergo broader transformation programs towards the "Branch of the Future", enhancing how branches operate and serve customers integrating seamlessly with the digital channels. The focus is on increasing customer experience and satisfaction, defining a seamless online/offline omnichannel integration, and re-thinking the activities to be performed at the branch. For instance, digital channels should not only serve as a direct sales channel but also as a lead generating channel bringing qualified traffic in the branches where final sale could take place. Moreover, the servicing model should be transformed to provide personalized face-to-face interaction only for value-added services for sales and advisory services, and high-volume business customers.
"Branch are here to stay," Mr. Philippe Chassat emphasizes. "However, their density, role and service model need to dramatically evolve to cope with clients' evolving behavior and increasing pressure on the retail banking economic model."
In addition to the short to medium terms challenges posed by the hefty investment in transformative technology in an environment of progressive margin contraction, banks have to further "tighten the ship" to cope with the sudden impact of the COVID-19. Accelerating the ongoing transformation programs with a broader perspective which also includes the rapidly changing customer's behavior will be key for Thai banks to successfully emerge from these challenging times.
Download the report on Roland Berger's website