Banks in Southeast Asia have made significant progress on their digital transformation journey, and incumbents that are willing to invest in technology are well placed to compete with fintechs, Moody’s said Thursday.

The rating agency said in a report that Southeast Asian banks have invested significantly in digital transformation to compete with fintech disruptors.

It said the outcome has been progress on multiple fronts: widespread customer adoption of their digital channels and improved product quality.

“The competitive space for digital financial products will continue to evolve, but Southeast Asian banks are well-placed to compete, given their track record over the past few years, and more so for large banks with the scale to make necessary investments,” said Moody’s.

According to Moody’s, banks have successfully transitioned their customers to digital channels.

It noted that customer transactions at the region’s leading banks are now largely processed through internet and mobile channels.

It is noted that not just in the payment space where there has been a sharp spike in digital adoption, new customer acquisitions across retail and small- and medium-sized enterprise (SME) products are also increasingly done online.

It said that most banks now offer a comprehensive suite of banking products digitally, across liabilities and assets, and for both retail and SME customers.

It said the banks have also made significant improvements in mobile user interface, closing the gap with fintechs and digital banks.

According to Moody’s, consumer mobile apps for leading banks are rated at 4 or higher out of a total score of 5.

It said high-quality user interfaces are now prevalent among leading incumbents and no longer a competitive advantage for the new entrants.

Furthermore, it said banks have been proactive in partnering with firms that has a digital footprint, within and beyond financial services, and to allow customers from these firms to access financial services through application programming interfaces (APIs).

For instance, in Thailand, KBank embedded its financial services into popular messaging app, Line, while Singapore’s DBS Group Holdings Ltd incorporated Gojek’s ride hailing service into its digital wallet PayLah! and vice versa.

These integrations create seamless user experience and expand the banks’ online presence, said Moody’s.

According to Moody’s, banks see digitalization as core to their overall strategy. This is reflected in the significant investments made over the past years and it expects this trend to continue.

Meanwhile, in most markets across emerging Southeast Asia, the deposit share of leading banks has been expanding partly because of their stronger digital franchise.

While Southeast Asia has a number of high-profile fintechs and they were able to build up large customer bases through digital payments, Moody’s noted that for most countries, their expansion in financial services is still modest.

These firms also remain loss-making, and given tighter funding conditions, will curb their expansion, said Moody’s.

According to Moody’s, in their respective markets, fintechs were the first to introduce digital payments through e wallets and Quick Response (QR) codes.

It said before the roll-out of national retail payment systems, the fintechs offered faster settlements than through card payments and bank transfers.

For merchants, it said QR code payments incur lower fees than credit card payments.

In addition, it said the new entrants pioneered “super” apps, which embed many lifestyle and financial services into a single mobile app.

It said that Southeast Asia’s fintechs typically offer financial services as part of a broader product offering, such as e-commerce and transport services.

It also said they have now expanded beyond payments into other financial services such as lending and have also entered the banking space.

“Some have secured digital bank licenses and in the case of Indonesian fintech firms, acquired ownership stakes in existing banks,” said Moody’s.

Moody’s also said the regulatory push for open architecture and the emergence of national retail payment systems are diminishing fintechs’ first-mover advantage in digital payments, where they have the strongest presence.

Tt said fintech expansion outside of digital payments remains limited.

Lending, which is a key focus, is still small. In particular, the penetration of buy now, pay later (BNPL) transactions remain low.

Similarly, it said Sea Limited (Sea), one of Southeast Asia’s largest consumer technology firms, reported $2.2 billion worth of net loan receivables as of 30 September 2022 – a small amount considering its sprawling operation across Southeast Asia.

Moody’s also noted that fintech disruptors business models yet to be proven, while challenging funding environment will curb pace of expansion.

“As with other start-ups, fintechs remain loss making. The financial service divisions of Grab and Sea, some of the most prominent tech companies in the region, are still making losses despite years of operations,” said Moody’s.

It said that for many fintechs, the payment business alone is not profitable and they have had limited success in cross-selling other financial services.

“We expect their increasing focus on lending to support revenue generation, but they will need to establish a track record in underwriting, as they typically lend to the unbanked and underserved who are traditionally risky segments,” said Moody’s.

It said that a very conducive funding environment prior to 2022 allowed these companies to sustain large losses while pursuing aggressive growth.

But it noted the funding environment has since tightened significantly, with fintech funding in Southeast Asia declining sharply in the third quarter of 2022.

It said these developments are forcing tech firms to implement cost-cutting measures and delay initial public offerings, which in turn will curb their expansion.

For instance, Grab Holdings Inc has been reducing incentives for its drivers and more recently, implemented salary freezes and budget cuts.

Meanwhile, Moody’s opined that regulations will continue to play an important role in the evolution of market structure.

It said that regulators seek to encourage financial innovation and do not intend to shield banks from new entrants.

At the same time, it said they seek to incentivize open architecture systems which makes it difficult for new entrants from using their captive customer bases to develop closed loop ecosystems.

To foster innovation, it said regulators have implemented or are in the process of implementing many initiatives to support fintech growth without compromising on financial stability.

These include regulatory sandboxes, rules on digital wallets, peer-to-peer (P2P) lending and APIs, as well as licensing frameworks for digital banks.

It also said the new licensing rules for digital banks have led to the proliferation of new entrants across Southeast Asia.

It noted that financial authorities in Singapore, Malaysia and the Philippines have issued new licenses under looser regulatory requirements when compared with those for commercial banks, while their Indonesian counterpart has encouraged acquisitions and digitalization of existing banks through higher minimum core capital and equal regulatory treatment.

It noted that Thai authorities too have drafted their licensing rules for digital banks in January 2023 and they plan to receive applications in the second quarter of 2023.

“All these initiatives will promote competition and provide a level playing field for new entrants,” said Moody’s.

Moody’s also said, the regulators seek to incentivize open architecture systems which makes it difficult for new entrants from using their captive customer bases to develop closed loop ecosystems.

It said the emergence of national retail payment systems across key markets in Southeast Asia is a good example of this.

It said this trend changed the competitive landscape especially for banks as the payment services they provide are now settled real-time and cost little to nothing for both consumers and merchants.

It said bank transfers are more convenient now that deposit accounts can be tagged to mobile, personal identification and business registration numbers.

It said regulators have also introduced interoperable QR codes which have seen widespread adoption for most countries in the region.

The use of interoperable QR code boosts payment efficiency by preventing market fragmentation and at the same time, prevents customers from being locked into a particular service provider, it added.

According to Moody’s the region has also taken a step further by connecting to these payment systems with one another under the Association of Southeast Asian Nations Economic Community Blueprint 2025, which in turn will facilitate cheaper, faster cross-border transactions.

It said regulatory initiatives have removed some arbitrage in rules and regulations that worked in favor of fintechs.

For instance, banks, which are subject to more stringent know-your-customer (KYC) rules, benefited from the introduction of electronic KYC regulations as they were able to offer remote deposit account opening.

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