By Luca Turba and Udomkiat Bunworasate
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. We estimate 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.
In an updated study to one that we published in February 2020, we estimate 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.
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. Banks will need to leverage on the change of mindset and habits of their customers by optimizing their digital transformation programs and physical network.
To tide through the pandemic, our study 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). 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.
Three short-to-medium cost containment initiatives were previously introduced in our previous study, such as accelerated zero-based budgeting, procurement excellence best practices and frugal IT to help bolster profitability and provide leeway for necessary strategic investments. Two additional key optimization approaches are recommended to tackle the current challenges, helping banks to further accelerate the ongoing transition from physical to digital channels and rethink their overall physical network footprint and their servicing models.
We recommend using advanced data analytics tools such as the "RB Branch OptimizerTM" to allow Banks to extract 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 also undergo broader transformation programs towards the "Branch of the Future", that would enhance the bank's operations efficiency and customer experience through defining a seamless omnichannel integration between its physical and digital channels, and re-assess 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. The servicing model should also be transformed to provide personalized face-to-face interaction only for value-added services such as sales and advisory services and high-volume business customers.
As banks face short to medium terms challenges posed by the hefty investments in transformative technology in an environment of progressive margin contraction, they now have to further "tighten the ship" to cope with the sudden impact of COVID-19. Accelerating the ongoing transformation programs with a broader perspective, that also includes the behavioral shift of customers' channel and servicing preferences, will be key for Thai banks to successfully emerge from these challenging times.
Second issue of Roland Berger's series on the Thailand Banking Market, where we focus on the current and future impacts of COVID-19 on the banking sector in Thailand, and recommendations for banks to emerge successfully from this pandemic.
