Alibaba: a help or hindrance to banking?
Hong Kong has become the latest country to shake up the banking industry by allowing big names in tech to set up online retail banking operations. But how significant is it for an industry long-controlled by the banks?
Banking has always been an exclusive club dominated by a handful of elite establishments that, over the centuries, have become a vital component of our financial lives. The high barriers to entry and stringent regulations have long protected the world’s leading banks, but their dominance has started to weaken and new rivals continue to surface with ambitions of stealing a slice of their pie.
In the past, the banks had to become accustomed to new financial services firms making waves in areas like payment processing. Since then, smaller, more digitally savvy challenger banks have taken a bite out of their bread and butter operations. Still, despite the disruption they have faced and the fact trust among consumers is still low following the financial crash, the world’s leading banks have remained on top.
But now they are preparing for what could prove to be the biggest threat yet as more countries look to stir up competition and open the industry to new formidable players – ones with the financial backing, customer insight and technological edge needed to shake things up.
Hong Kong has become the latest financial hub to have paved the way for a number of big names to begin offering banking services, including Chinese conglomerates Alibaba and Tencent. As we sit on the cusp of this new era of banking, we explain why this change is so significant and what it could mean for the newer entrants and the old incumbents.
Hong Kong banking industry opens up to Alibaba and Tencent
Earlier this year, the Hong Kong Monetary Authority (HKMA) began to issue a new type of ‘virtual’ banking licence to companies that want to offer retail banking services online, and ordered existing banks to accommodate them by adopting the infrastructure needed to let their new rivals operate. Reports suggest over 30 companies and joint ventures have applied for the new virtual banking licenses but only eight have been dished out so far, although many more are expected to follow.
Hong Kong’s eight new virtual banks
|Virtual bank licence awarded to…||Ownership details|
|Ant SME||Owned by Ant Financial (which is owned 33% by Alibaba)|
|Insight Fintech||JV: Xiaomi and AMTD Group|
|Infinium||JV: Tencent, ICBC, Hillhouse Capital|
|Livi VB||JV: Bank of China, JD Digits, Jardines|
|SC Digital||JV: Ctrip, HKT, Standard Chartered, PCCW|
|PingAn One Connect||Owned by PingAn|
|WeLab||Owned by WeLab|
|Zhong An Virtual Finance||Owned by ZA International|
The HKMA has said these new virtual, online-only banks are aiming to be up and running within just six to nine months. This follows on from moves in other countries toward open banking, including the UK’s Open Banking initiative and the EU’s second Payment Services Directive (PDS2). Some anticipate other countries will continue to follow this path, including Singapore.
The idea of online-only banks is not new, with small ‘challenger banks’ having popped up across Europe over the past decade. But the imminent entry of companies like Alibaba – a $440 billion powerhouse spanning everything from ecommerce to cloud computing – represents a whole different kettle of fish.
What you need to know about Alibaba and Ant Financial
Alibaba is a versatile Chinese conglomerate that generates the vast majority of its revenue from its ecommerce sites but it also has fast growing cloud computing and digital entertainment arms. The company established Alipay in 2004 to handle payments and transactions on its sites and Alibaba’s founder, Jack Ma, controversially spun off the division in 2011. While the Alipay brand lives on today, the new company changed its name to Ant Financial in 2014, with the Ant representing its focus on helping small businesses and those outside the sphere of traditional banking.
The company continues its vital role within Alibaba’s ecosystem and last year Alibaba said it would buy a 33% stake in Ant Financial. Many saw that as a precursor to Ant Financial launching an initial public offering (IPO), and earlier this year the pair announced they would set up a new steering committee to ensure the two companies remain aligned going forward even if they are two standalone businesses.
There are obvious benefits for an ecommerce giant like Alibaba having its own payment processor. It gives it greater control over the end-to-end shopping experience and cuts out the costs of hiring an intermediary. This is why there has been expectations for Amazon to enter the field, possibly with the help of a bank, but the regulatory picture in the US is more complex due to the layers of state and federal legislation. Still, we have seen others combine a well-regarded consumer brand with regulated financial products, such as Apple and Goldman Sachs' agreement to launch a new credit card.
Ant Financial: the $150 billion giant
Ant Financial may not be the best-known business but its 1 billion-plus users and its $150 billion valuation means it should be. It earned that price tag under a humungous $14 billion fundraise in June 2018 – thought to be the largest ever single fundraising to be conducted globally by a private company. That valuation has almost doubled since 2014, when it changed its name and raised $4.5 billion to be worth $60 billion.
Investors in the most recent fundraising last year included Malaysian SWF Khazanah Nasional Bhd, US private equity firms Silver Lake, General Atlantic and Warbug Pincus, as well as Singaporean sovereign wealth fund (SWF) GIC Pte and Singapore’s state-controlled investor Temasek Holdings.
Although Ant Financial’s primary source of revenue has come from its payments division it has added a string of new financial products that customers can access. For example, it launched Yu’E Bao (or ‘spare treasure’) in 2013 to allow people to quickly and easily deposit excess funds in an interest bearing account. And, in 2015, it began offering revolving credit to consumers, launched SME-focused MYbank and a new wealth management app, Ant Fortune, which encourages users to manage all their finances from one centralised app.
Is Ant Financial launching an IPO?
The company has long been rumoured to be preparing for an IPO, with some believing Ant Financial could go public in Shanghai as early as this year. Although it raised $14 billion last year the company has been aggressively expanding into new territories and areas, enough so that Alibaba is not reaping any takings from the business at present.
More countries to open up banking to tech industry
Although attention is on Hong Kong, virtually all the new virtual banks – including Ant – have big global ambitions. Ant Financial has already broken into other major banking sectors across Asia-Pacific and beyond, mainly by partnering with and investing in local partners. For example, it has secured a payment banking licence in India through the country’s largest payment provider, Paytm, which it has invested in. It bought helloPay in Singapore and purchased a large stake in Kakao, which runs the largest messaging platform in South Korea and is one of the only new companies to have been awarded a digital banking licence in the country. Much like the success of Tencent in getting people to pay through their messaging apps, Kakao’s 28 million users conducted over $17.5 billion worth of payments through its platform last year.
The biggest move in Ant’s international expansion so far has been its acquisition of UK-based payments provider WorldFirst, giving it a springboard to launch into Europe. WorldFirst competes in the remittance market where people transfer money overseas and the purchase allows Ant to introduce its other products – including Alipay – to more western merchants and consumers.
What’s the risk to existing banks like HSBC and StanChart?
Hong Kong’s banking industry is primarily dominated by a handful of Chinese banks and the likes of HSBC and Standard Chartered (StanChart). And for anyone unaware of the outsized role Hong Kong plays in the world’s financial engine, the city boasts a population of just 7.4 million people and yet it is by far the largest single market for both HSBC and StanChart. Hong Kong accounts for over one quarter of StanChart’s net interest income and just under half of HSBC’s revenue and the bulk of its profit.
Biggest banks in Hong Kong
Below are the top banks in Hong Kong based on total assets in 2018, according to KPMG. Licensed banks are allowed to offer current and savings accounts to customers, but a restricted licence limits the bank’s operations, primarily to merchant banking and capital market activities:
|Top 10 licensed banks in Hong Kong||Top 10 restricted licensed banks in Hong Kong|
|HSBC||Morgan Stanley Asia International|
|Bank of China (Hong Kong)||Bank of Shanghai|
|Hang Seng Bank||Scotiabank|
|Standard Chartered||Siam Commercial Bank Public|
|Bank of East Asia||JPMorgan Securities (Asia Pacific)|
|China Construction Bank||Bank of China International|
|Nayang Commercial Bank||KDB Asia|
|DBS Bank||Citicorp International|
|China CITIC Bank International||ORIX Asia|
Open banking is forcing banks to accommodate new rivals
The HKMA has not only allowed these new online banks to open their virtual doors but has told the incumbents that they must welcome them with open arms by adopting open banking. Open banking is forcing the banks to share the vital account information and transaction data that approved third parties, such as the virtual banks, need to launch new innovative services to the market. This will effectively break up the bank’s long-held monopoly over this information and hand back control to consumers, who will decide which firms the bank shares their data with.
If Alibaba, Tencent or any of the other new entrants launch a product or service that a consumer is interested in then they will be able to force their bank to give the company access to their account. This provides new services to customers and crucial transaction and spending data to the businesses providing them.
This has led to two distinct types of relationships emerging between the existing banks and these new entrants in countries where open banking is being pursued. In Singapore, which is touted to follow in Hong Kong’s footsteps, fintechs are primarily offering their services through the banks, making them valuable partners to the industry able to provide the new digital services they need. However, it is more of a mix in the UK, where many fintechs and online-only banks have decided to bypass the banks, directly compete and offer their services directly to customers.
These two relationships offer dramatically different dynamics; one that sees tech companies help banks move into the digital age, expand their reach and lower their cost of acquisition, and another that sees some of the world’s biggest tech companies directly compete with the world’s long established banks.
In Hong Kong, it is interesting that HSBC and StanChart have taken very different approaches, suggesting it is not yet clear what relationship the banks will have with their new virtual rivals. While StanChart has teamed up with Ctrip, HKT, and PCCW to create a new virtual bank that will effectively compete with itself, HSBC has not applied for a new virtual licence and has instead decided to build on its existing digital operations. Most of the largest banks have had a tough time moving away from their out of date computer systems to new cloud-based platforms, so many have decided to launch new digital brands with completely fresh IT infrastructure. These new brands are often targeting a different type of consumer to the main brand, usually the younger generation more accustom to living through their mobile phone. This has been the predominate choice in the UK, where most of the major banks have launched standalone digital brands.
Defining the relationship: are Alibaba and Tencent partners or rivals?
Although the creation of new virtual banks is largely portrayed as a story of new competition threatening the long established banks, Alibaba’s affiliate Ant Financial believes this is misguided.
In 2017, Ant Financial made 70% of its revenue from processing payments, 15% from its other financial services and another 15% by providing technical services to banks and other financial institutions who need assistance in the digital age. However, last year it made only 54% from payments and 11% from financial services as it tilted more toward supplying the industry with technical services, which accounted for 34% of total revenue.
This is evidence that Ant Financial is pivoting more toward helping the banks rather than competing with them. Late last year, the deputy chief technical officer of Ant, Hu Xi, said the business was increasingly providing technical help in areas such as financial security and blockchain. The company believes it will be making 65% of its revenue from providing technical products and services to the likes of banks by 2021, when payments will make up just 28% of the business and financial services will be a paltry 6%.
Ultimately, Ant Financial believes supplying the technology needed to facilitate open banking is the long term prize so it can be the vital glue that holds it altogether rather than a bit-part. This means it can take a slice of everyone else’s pie instead of chasing after its own. IBM has taken a similar approach in cloud-computing where it is focused on becoming a vital partner to the entire industry rather than competing head on with huge firms like Amazon, Google and Alibaba.
While many believe the likes of Alibaba and Tencent could have what it takes to rival established banks like HSBC and StanChart, this overlooks the benefits of combining the two.
New rivals have large reach to offer new products in new formats…
The firms about to enter Hong Kong’s retail banking market bring a variety of new ways to evolve an ecosystem that either works with or against the banks. Remember, these are not banks: Alibaba’s strength is in ecommerce, Tencent’s is in entertainment and gaming, Ctrip is a travel firm, and Xiaomi is predominantly known for making smartphones and scooters. This will see them integrate people’s financial lives into other areas of their digital life, whether that be their online shopping, how they travel or how they use social media. It will result in financial products being increasingly bundled together with non-financial ones. For Ant Financial and its partner Alibaba, this allows them to bundle new financial products alongside non-financial offerings: such as when they are shopping. This improves the ability to cross-sell and enhances the data that can be collected, which in turn drives further cross-selling to kickstart a flywheel effect.
Tencent, for example, already let users make payments through its messaging apps which has proven particularly popular among consumers in China looking to transfer small amounts to friends or others. Ant Financial already offers new innovative financial products within its own platform that allows users to select the likes of Yu’E Bao, where you can put spare cash to earn interest, or Ant Fortune, which allows them to make higher yielding investments. This ultimately shifts transactions from the banks to these new tech rivals, which allows them to capture valuable data.
Firms like Alibaba and Tencent have already proven their ability to undercut and better serve consumers in China, and mainly because a purely digital presence means they have much lower costs. This means they are in a much better position to make the likes of small business loans or microtransactions profitable, but even if they can’t do it profitably they still have reason to offer them because offering credit or other services can help drive sales in other areas of the business.
It is also the fact that both these companies not only have the ability to introduce new products but that they have reach that a bank simply cannot compete with. Alipay, Alibaba’s payment system run by Ant Financial, has over 1 billion users while Tencent’s WeChat Pay has about 900 million (Alibaba’s marketplace sites has around 600 million, which trails Tencent). With both companies boasting so many tentacles they each have the ability to cross-sell new financial products to users of their other digital services. With such a variety of tech companies looking to enter, users will be able to increasingly manage their financial lives while they shop online, order a ride hailing cab or enjoy online entertainment.
But banks have expertise and sticky customers
These new entrants will be able to attract consumers to their retail banking operations by differentiating themselves through their other digital activities: providing discounts when you shop online, providing a free streaming subscription or maybe early access to buy tickets for music or sporting events, for example.
Banks around the world have long been criticised for a lack of differentiation. There is very little incentive for people to move banks and switching levels are, generally speaking, extremely low. Even in markets where new challenger banks have been introduced, like the UK, as little as 3% of the population switch every year. This means the new entrants can decide to leverage their digital offerings to try to steal custom away from the banks or supply the banks with the services to help them attract more customers. Even if new tech rivals have the ability to steal customers away from traditional banks using their wider offerings they may find working with the banks is a quicker and more lucrative way to break into banking.
There is clear potential for existing banks to partner new entrants like Alibaba and Tencent as a way of reaching new customers at a lower cost and launching more personalised products to consumers. The trouble might be convincing the likes of Alibaba and Tencent that they are better off aiding the banks rather than competing against them. The biggest strength the bank’s have is their expertise and greater regulatory approval.
However, the banks face major risks even if they do decide to partner with these new virtual banks. If banks partner with these new rivals then over the long term they risk becoming nothing more than a supplier of regulated financial services to the tech industry, which would be capturing all the transaction and customer data that is vital in order to cross-sell. While there are already some ‘white label’ banks (also known as Banking as a Service) that only provide regulated financial services on behalf of other businesses that are profitable, they are regarded as lower margin businesses that are interchangeable – and this is what banks risk becoming if they fail to manage the relationship with the tech industry successfully. Consultancy EY states around 70% of all the value in retail banking is captured by those offering and distributing the products with just 30% attributed to manufacturing them.
Alibaba and the banks: who will be the supplier?
Although the banking industry has faced many new entrants that have disrupted their businesses before, never have they been so well capitalised. It is early days for Ant Financial and although it is plotting a global break into banking it has already suffered some severe setbacks that may help explain why it is hoping to partner the banks and help solve their technological woes rather than compete against them.
For example, at home, authorities have looked to slow the pace of Ant’s growth by imposing daily limits on transfers using Alipay and capped the amount of cash that can flow in and out of Yu’E Bao. Its expansion abroad has also been held back after its attempt to buy US payments giant MoneyGram for $1.2 billion was blocked by the US government.
Ant is aggressively expanding its banking operations abroad but it comes at a time when relations between the east and the west are far from ideal. The controversy over Chinese telecom giant Huawei and the role it plays in developing 5G technology in the US, Australia, Canada, New Zealand, the UK and parts of Europe is being criticised for potentially leaving vital security infrastructure exposed to the Chinese government. And that is further exacerbated by the US-China trade war that continues to escalate. Deciding to work with the banks rather than against them may be the best way for Ant to avoid any regulatory or political controversy as it expands, but that does not mean it is not aiming to rival them over the longer-term. It all comes down to how these relationships dictate who captures the value and who becomes the supplier.
It seems Alibaba and other tech companies are looking to supply in the short-term, but make no mistake that they have their eyes on capturing the real value over the longer-term. Banks may view these new entrants as a way of improving their digital services, lowering the cost of acquiring new customers and improving the way they can serve customers to truly differentiate themselves, but they must ensure they do not gradually become a vessel for their new partners to conduct regulated financial activities.
How to trade this trend?
Investors can not invest or trade shares in most of the new virtual banks to emerge in Hong Kong, either because they are private businesses or joint ventures made up of several entities. You can consider taking a position on Ant Financial through Alibaba, but remember it is not a direct part of the company and is a standalone business, albeit one with tight relations with the ecommerce firm. Otherwise, you will want to keep an eye out for any news on any potential IPO by Ant Financial which, if pursued, will be huge for markets.
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