Morgan Stanley
  • Research
  • Dec 18, 2020

Asia Banking 2025: Crossing the Digital Divide

The pandemic has tested the resilience of Asian banks and could widen the growth gap between digital leaders and laggards in the coming years.

Asian banks experienced strong growth and profitability in the years leading up to 2020, thanks to broad economic expansion and surging demand for financial services, in areas such as commercial banking, retail lending and wealth management. COVID-19 has tested the sectors’ resilience, widening the gap between the region's digital leaders and laggards.

Asia banking's digital leaders of tomorrow could deliver up to 4% to 5% higher returns on equity by 2025, vs. the sector's slower adopters.

“For Asian banks, digitalization has emerged as the highest priority of the post-COVID-19 agenda. Digitalization will be necessary to defend market share, or to exploit growth opportunities in markets such as India, Indonesia, or China," says Morgan Stanley Research equity analyst Nick Lord

Meanwhile, slow adopters face a complex, multiyear transformation and risk losing ground to digital leaders and emerging competitors, including Super Apps, which bundle banking with other services, such as social media and e-commerce.

According to a collaborative report from Morgan Stanley Research and consultancy Oliver Wyman, the digital leaders of tomorrow could deliver up to 4% to 5% higher returns on equity by 2025, vs. the sector's slow adopters. Yet, doing so will require concerted efforts to scale and accelerate change, upgrade digital capabilities and capture emerging growth opportunities.

“With lower policy rates likely here to stay until at least 2023, banks have limited levers to pull to raise returns. Digitalization could help maximize efficiency gains and defend against emerging risks, including client expectations, regulation and new market entrants," Lord says. “The question is whether or not this will be sufficient."

Digitalization should accelerate post-COVID-19
(Impact of COVID-19 on digital disruptors in the market)

Source: Alphawise, Morgan Stanley Research. Base size=15.

Confronting the New Normal

The pandemic has disrupted every industry around the world. For banks, these challenges include a sustained lower policy rate environment, pressure on fee revenues, increased credit costs and a greater strain on infrastructure across banks in Asia. “While some of these pressures will recede with the pandemic, low interest rates will continue to put material pressure on bank returns for the next 2-3 years," Lord says.

The report forecasts that return on equity, a key barometer of performance in the financial sector, will be under pressure relative to 2019 in all Asian markets, with the exception of India, where credit-cost normalization could offset income pressures. The drop in return on equity will be most meaningful for banks in Korea, Singapore, Hong Kong and Thailand where the low rate environment will continue to put material pressure on bank returns in the medium term.

Revenue benefits relative to income headwinds
(Drivers of RoE change, %)

Source: Oliver Wyman, Morgan Stanley Research. E=Morgan Staney Research estimates.

Paradoxically, behavioral changes of customers and employees working remotely have put pressure on profits—but they have also fast-tracked digital development among banks. Consider key segments:

Retail Banking: Consumers have shifted spending from physical stores to e-commerce, with digital payment usage more than doubling. Amid social-distancing rules, they've also switched to digital banking, which has raised the risk that more retail customers will embrace digital banking alternatives via “super apps” which let users pay for meal or a ride, alongside shopping or hanging out on social media.

Wealth Management: On the one hand, wealth management for a burgeoning class of well-to-do clients could be a key driver of growth for Asian banks; on the other hand, new market entrants who charge 50% lower fees could put pressure on incumbents, in a long and costly battle for market share.

Small Business: Surveys show that banks haven’t met the digital service expectations of small and midsized enterprises, an underserved segment. Access to credit continues to be a top need, as are increased expectations for ease of access to a broader range of financial services via digital channels.

Commercial Banking: Corporate customers increasingly expect a wider range of offerings from banks, such as digital onboarding, advisory, digital sector solutions and fintech partnerships. COVID-19 has underscored this. Leading corporate banks in Asia have seen a spike in digital channel utilization—53% report a large increase—but up to 60% of corporate clients still remain dissatisfied with their bank's digital offerings.

Banks see retail/household lending and SME lending revenue lines as most negatively impacted by COVID-19

Source: AlphaWise, Morgan Stanley Research. Base=14 respondents.

Digitalization and Belt Tightening

Given these challenges, the traditional responses to a lower rate environment, such as focusing on new fee strategies and increasing asset spreads, might not work. Changing digital preferences also allow new, more agile entrants to compete.

Asian banks will need to accelerate their digital transformation, with a particular emphasis on cutting costs, for example, by closing some branches and using more automation. “The main benefit of digitalization will be cost savings, but digitalization cost savings on their own will not be enough to offset revenue pressures," Lord says. 

Digitalization savings make up to 60% of Morgan Stanley Research cost savings forecast
(Digitalization savings as a % of Mse cost savings)

Source: Oliver Wyman, Morgan Stanley Research. E= Morgan Stanley Research estimates

The Morgan Stanley and Oliver Wyman teams analyzed and quantified the impact on returns for banks across the region using three key pillars:

  • Growth: The ability to capture new customer segments through financial inclusion
  • Efficiency: The ability to streamline, redesign and automate systems and processes.
  • Resilience: The ability to protect against future shocks, while providing customers with safe, secure and scalable service, in the face of increasing economic uncertainty.

Sizing Up Local Leaders

While every regional market has its own dynamics, banks in China, India and Indonesia are potentially seeing the most benefit—and dispersion—from digitalization.

“The gap between digital leaders and slow adopters will be bigger in China than in other markets," says Richard Xu, who covers Chinese financials for Morgan Stanley; his team estimates that digitalization will add 60 basis points to Chinese bank returns by 2025, with the biggest benefits coming from cost reductions.

In IndiaMorgan Stanley finds that large private banks are best positioned, with significantly improved product offerings, distribution capabilities, underwriting practices and cost ratios. “They are at the forefront of various digitization initiatives, and we think they will further improve their market share in relatively high margin loans, as well as improve costs ratios," says Sumeet Kariwala, who covers Indian banking.

Finally, in Indonesia, increased digitalization has helped drive  significant cost savings, while making it possible for leading banks to extend their reach to new customers, including so-called micro borrowers.

For more Morgan Stanley Research Asian Banks ask your Morgan Stanley representative or Financial Advisor for the full report, “Asia Banking 2025: Digitalization to Redefine the New Normal" (October 13, 2020). Plus, more Ideas from Morgan Stanley's thought leaders.