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Banking in Emerging Economies: Trends and Technology

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Banking in emerging economies: trends and technologyIt is rather ironic that it took a global financial crisis of massive proportions for emerging market banks to unleash their potentials. Although banking institutions from all over the world were impacted by the crisis, those in emerging markets were hurt less thanks to a combination of prudent banking and capital management practices, the existence of huge unbanked markets which continued to fuel growth, and a relatively healthy macroeconomic situation.

Technology has played a major role in the development of the banking sector in emerging markets. A well known technology analyst firm predicts that emerging economies in Asia will increase their spending on retail banking technology by 8.3% in 2012, to cross US$ 10 billion by the end of the year. A factor in the favor of emerging market financial institutions is that they are not burdened by vast legacy systems (unlike banks in developed nations), which has enabled them to adopt modern IT systems and easily integrate the same with existing infrastructure. This is reflected in the number of new Core Banking System implementations in the markets of Africa, Latin America, East Europe and Asia. Not surprisingly, almost all core banking service providers have shifted their focus from the debt ridden western economies to these emerging markets.

The new IT systems have helped emerging market banks achieve scalability and mitigate the limitations of their erstwhile solutions. For example, they have dismantled IT system silos by integrating the banks’ existing applications to provide a 360 degree view of customers encompassing their products, preferences, relationships and transaction history and thereby

Emerging market banks, which were already growing faster than their developed world counterparts prior to the crisis, have picked up the pace further in the last few years. 8 of the world’s 25 largest banks by market capitalization come from emerging markets; and together, emerging market banks accounted for approximately one third of both global banking revenues and profits in 2010.

Changing landscape of banks’ IT systemsenable customer facing bank executives to serve and cross-sell more efficiently.

The Central Banks in emerging markets have also automated various processes and transactions. For instance, the Reserve Bank of India has successfully adopted Real Time Gross Settlement (RTGS), which is now the fastest system of money transfer within the banking channel and is available at over 72,000 bank branches across India.

Mobile leads the pack

Of the various trends and technologies in the emerging markets banking landscape, mobile banking is unarguably the front-runner. Thanks to their reach, ease and capabilities, mobile devices have outperformed the ‘e’ space, to achieve a penetration of more than 50% even in countries with per capita GDP as low as $5000. In fact, 75% of global mobile subscribers are located in emerging markets.

With the telecom sector flourishing in developing countries such as China and India, banks in these regions are moving to tap this extensive mobile coverage to make their services more inclusive. This has all the makings of a win-win situation: banks can now reach out to the

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Banking and financial services institutions in emerging markets stand to benefit exponentially from cloud computing. Cloud computing has made even expensive technology infrastructure accessible to smaller institutions by way of a pay-per-use business model. A research firm claims that this model cuts costs by as much as 30% when the IT infrastructure is managed by specialist IT vendors.

One of the leading IT vendors in the cloud computing space recently announced a deal with an Indian Public Sector Bank to extend their banking services in 5,500 unbanked/under-banked areas, and expand their reach to over 3.5 million customers in the next three years. The applications will be hosted on cloud computing technologies, which create an easy-to-access, highly-secured environment that provides reliable world-class infrastructure and application services in a cost-effective and efficient manner. The same IT vendor has tied up with rural and co-operative banks in India to help them automate and integrate their processes pertaining to deposits and loans, for a fixed monthly fee for each service outlet. It already serves nearly 2,000 bank branches through this model.

Encouraged by the success of cloud computing, more and more IT companies dealing in banking products are putting their core banking solutions on the cloud.

Importance of prudent regulations

Warren Buffet remarked once “Only when the tide goes out do you discover who’s been swimming naked.”. The financial crisis has

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millions of unbanked mobile subscribers in far flung areas (where it is unviable to set up expensive branch infrastructure), using a low cost mobile delivery platform. The iPhone and Android platforms have given a new definition to plug and play third party applications. Many banks in emerging markets have launched their mobile applications using which their customers can transact

The need of the hour is closer collaboration between banks and telecom service providers and a supportive regulatory environment that enables these players to benefit even as they serve the basic banking needs of vast unbanked regions.

demonstrated the amplification of Pro-cyclic effects as financial firms acting in individual prudent manner collectively shaped systemic break-down. It triggered a strong response from regulatory authorities worldwide, who devised policy tools for countercyclical capital requirements to limit the leverage and excessive liquidity in the system. The financial crisis highlighted the need to intertwine macro and micro- prudential instruments.

Once criticized for their conservative approach, the regulatory agencies in emerging economies stood vindicated when their defensive policies came to the rescue of their financial institutions, even as those in the west paid the price for espousing excessive liquidity and risky financial instruments. Asia has been remarkable for keeping credit growth in check and managing its asset prices. The Reserve Bank of India has been acknowledged worldwide for its pragmatic approach to banking regulation.

Financial innovation

Global banks entering emerging markets have understood their diverse demographics and recognized their unique needs and expectations. The traditional approach of flogging stripped-down models and products – taken from developed markets – no longer works in the emerging world. Hence banks have started to establish new hubs of innovation and experimentation locally in emerging markets, catering to their ground realities.

A reverse innovation trend of taking innovations and experiments from emerging markets to

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the developed world has been set in motion. A good example is that of Deutsche Bank, which was finding it hard to compete on costs with its local rivals in emerging markets, who typically enjoyed a 30-50% advantage in cost/income ratio. In Mumbai, Deutsche Bank moved all back office activities to a separate hub in North

Emerging markets are slowly opening their doors to foreign and private banks by ushering in privatization. In a few economies of Eastern Europe, market forces are deciding the destiny of state-run banks; in others like India and China, the state is deciding their fate. There is clear evidence that privatization of banks coupled with the entry of foreign banks has had an overall positive effect on the banking system. Not only has it helped to improve the efficiency of Public Sector Banks by intensifying competition, but it has also benefited customers through wider credit and better services.

Central Banks in emerging economies are playing a key role in encouraging the consolidation of the banking sector. According to a World Bank study, foreign banks have continued unabated acquisitions and mergers with local banks thereby controlling over half of the banking system assets in Argentina, Chile, Czech Republic, Hungary, Poland and Mexico. One reason why the authorities are interested in consolidation is so that they can resolve the problems of financial distress by mediating the sale of troubled institutions to private banks.

Banks in emerging economies prefer less leverage than their western peers

At the peak of the financial break-down in 2008, banks in the US and Europe had pushed their leverage ratios – expressed as Tier 1 Capital as a proportion of total adjusted assets – from a level of X20 to a very high X40. A few large banks had pumped their assets to a level of X60 to X100 compared to their equity.

Banks and consumers in emerging markets are typically much less leveraged than their

Mumbai where compensation costs were one quarter of those in its erstwhile plush South Mumbai location. The Bank then replicated this approach by moving its US equity research arm from New York to Florida, where wage rates were comparatively low.

Structural changedeveloped-market peers, as they did not indulge excessively in exotic financial products based on excessive leverage. Once again taking the example of China and India, banks in these emerging economies have realized the wisdom of maintaining low leverage. On the one hand it has given them more options to deploy their funds and on the other, it has put them in a comfortable position of capital adequacy. The strategies of all banks in these markets are based on growth, and not leverage. This is in contrast with western markets where the buildup of excessive leverage within the system eventually burst the financial bubble.

Financial inclusion

The capital cost of infrastructure, the risk of high NPAs in rural areas, shortage of resources, weak delivery models, and lack of suitable products have deterred banks from entering rural markets in a big way.High operational costs coupled with expensive technology have made it both complex and unprofitable to run a rural banking business. This has unfortunately deprived those most in need of financial services. It is imperative for financial institutions to come out with leaner operating models, tailored product offerings, and cheaper technology in order to break this impasse and do profitable business.

IT service providers have sensed this opportunity, and have amended their product strategies to serve the needs of emerging market banks, especially rural and small co-operative banks, which have much scope for growth. They have come up with low-cost and simplified versions of their core banking software, in the form of a

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‘bank-in-a-box’ solution that can be implemented quickly. This has helped financial institutions deliver end-to-end services at an affordable cost to low-income groups in regions where banking services are not fully operational.

Emerging markets are here to stay. With changing landscape, Onus now lies on emerging markets to step up and spearhead the positive financial developments. Larger sections who missed the train last time need to be benefited this time.

South Africa’s banks have set an excellent example by developing many innovative and customized products for such markets, and are using the mobile and postal network to spread financial inclusion.

ConclusionThe growth has to be inclusive. Though the challenge is trade-off between fast growth and risk it brings along, the answer lies in Buddha’s prolific teaching of ‘Middle Path’

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Varun GoyalSr. Consultant – Finacle, Infosys

Finacle from Infosys partners with banks to transform process, product and customer experience, arming them with ‘accelerated innovation’ that is key to building tomorrow’s bank.

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