Russian Financials - Who Innovates Wins: Lifting the Lid ...€¦ · SBERBANK CIB INVESTMENT...

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INVESTMENT RESEARCHRUSSIA | FINANCIALS

OCTOBER 2016

Russian Financials Who Innovates Wins: Lifting the Lid on Fintech in Russia

Andrew Keeley +44 (207) 936 04 [email protected]

Andrey Pavlov!Rusinov +7 (495) [email protected]

OCTOBER 2016 RUSSIAN FINANCIALS – WHO INNOVATES WINS: LIFTING THE LID ON FINTECH IN RUSSIA

2 SBERBANK CIB INVESTMENT RESEARCH

Companies profiled in the report Mcap$ mln

Target price

Rec.

Sberbank 53,544 ! NRMoscow Exchange 4,132 R138 BUYTCS 1,570 $8.0 BUY

Source: Bloomberg, Sberbank CIB Investment Research

Global fintech funding, $ bln

2.64.4 5.2

10.0

18.9

25.2

14.7

0

5

10

15

20

25

30

2010 2011 2012 2013 2014 2015 2016YTD

Blockchain Data and analyticsInsurance Lending/crowdfundingPayments PlanningSecurity Trading and investments

Note: 2016 data as of July 2016.

Source: The Boston Consulting Group

Card transactions by country

96%

91%

89%

88%

83%

79%

76%

75%

70%

59%

53%

53%

52%

50%

50%

49%

44%

41%

38%

36%

35%

29%

14%

14%

0%

20%

40%

60%

80%

100%

Cana

daSo

uth

Kor

ea US

Chin

aSw

eden

Den

mar

kFr

ance UK

Net

herla

nds

Port

ugal

Spai

nTu

rkey

Japa

nBr

azil

Italy

Aus

tria

Ger

man

ySo

uth

Afr

ica

Pola

ndCz

ech

Rep

ublic

Hun

gary

Russ

iaIn

dia

Gre

ece

Card payment transactions ATM transactions

Note: Data as of 2015.

Source: Euromonitor

Sberbank Online, active users, mln

8,015,8 18,8 16,4

0,9

2,2

5,8 7,5

0,5

1,4

4,6 10,0

0

10

20

30

40

2013 2014 2015 9m16

Web only Web and mobile app Mobile app only

9.4

19.4

33.929.2

Source: Company

POS terminals in Russia, mln units

0.0

0.3

0.6

0.9

1.2

1.5

1.8

Dec

’07

Jun

’08

Dec

’08

Jun

’09

Dec

’09

Jun

’10

Dec

’10

Jun

’11

Dec

’11

Jun

’12

Dec

’12

Jun

’13

Dec

’13

Jun

’14

Dec

’14

Jun

’15

Dec

’15

Jun

’16

Source: CBR

Russian FinancialsWho Innovates Wins: Lifting the Lid on Fintech in Russia In this report we lift the lid on the development of fintech in Russia. Globally, fintech is a hot topic, receiving $25 bln of equity financing last year alone. This has spurred a lively discussion about whether the emergence of new entrants in financial services that can seemingly do things faster, better and cheaper marks the start of the long demise of banks. As is often the case, things are slightly different In Russia, with the modernization of financial services to a large degree being driven by some of the leading banking names, which appear to be more ahead of the game than many of their Western peers.

█ Setting the fintech scene. We look at how fintech is disrupting retail banking on the global stage, from the arrival of digital banks and P2P and online lending to the emerging payments battleground, the potential (or otherwise) of blockchain and digital currencies. We find that it can be tough taking on existing banks, some of which seem to be finally waking up to the need to change, and building sizable and profitable businesses. The payments space is probably the main area in which banks risk losing the front!end customer relationship and being relegated to “being the dumb pipes.”

█ Russia’s maturing financial landscape. By many indicators, Russia remains a financially immature country, though this is changing. About 25% of the adult population remains outside the banking system and, unsurprisingly, cash still dominates. But the banking infrastructure is well developed – for example, Russia has more ATMs per capita than the UK or Japan – and the share of card payments in total card transactions has risen to almost 30%, buoyed by a network of over 1.5 mln POS terminals. The popularity of mobile banking is also exploding, driven by high smartphone penetration.

█ Fintech: The Russian nuances. Fintech in Russia definitely has its own style. For one, some big banks are taking the lead in innovation, and here we dive into what the likes of Sberbank (whose online platform has over 33 mln users) and Tinkoff, two of Russia’s fintech leaders, are up to. But there are things happening beyond the leading banks, and we profile a broad spectrum of interesting names in areas spanning digital banking, microfinance, payments, POS lending and mobile acquiring, although admittedly the scale of many of these businesses is small. In terms of longer!term risks to banks’ traditional revenue streams in Russia, we see the payments space as the likely source of the most disruption.

█ Interviews with leading fintech names. We have also spoken with fintech leaders in different areas, from a global “guru” (Moven’s Brett King) to one of Russia’s original “fintechers,” Oleg Tinkov, and the founder of a couple of fintech startups in Russia, to get some different perspectives on the challenges that fintech startups may pose to the incumbent banks.

RUSSIAN FINANCIALS – WHO INNOVATES WINS: LIFTING THE LID ON FINTECH IN RUSSIA OCTOBER 2016

SBERBANK CIB INVESTMENT RESEARCH 3

Contents

Investment Summary ....................................................................................................................... 4

Introduction ..................................................................................................................................... 7

Setting the Fintech Scene ................................................................................................................. 8

Brett King, Founder and CEO, Moven ............................................................................................. 26

Russia’s Financial Development ...................................................................................................... 29

Oleg Tinkov, Founder and BoD Chairman, Tinkoff .......................................................................... 38

Sberbank ........................................................................................................................................ 41

Tinkoff ........................................................................................................................................... 51

Moscow Exchange ......................................................................................................................... 57

How Fintech Fits Into Financial Services in Russia ............................................................................ 60

Irene Shvakman, BoD Chairman, Revo Technologies and Sorsdata ................................................. 71



Investment Summary

Fintech has been generating significant buzz in the West in recent years, in no small part due to its enormous potential to bring about massive change in how banking is done. These developments will certainly not leave Russia untouched, a theme that we examine in this report. We first set the scene for how fintech is reshaping the discussion about retail banking in the West, then offer a snapshot of Russia stands in terms of financial maturity, and, finally, we probe some of the particulars of the development of fintech in Russia.

█ Fintech – is this time different? Fintech has arguably already been changing banking for several decades, starting with the advent of ATMs and SWIFT in the 1960s and 70s to the first internet banks in the 1990s. But things seem different now as rapid technological advancement may be starting to reshape banking in the way it has other industries such as music, publishing and telephony. In fact, fintech equity financing has surged from $3 bln in 2010 to $25 bln last year.

█ The challenge of building sustainable new businesses. We assess the main changes across the spectrum of retail banking, from the advent of digital banks and the battleground of payments, to P2P lending and payments, online lending, crowdfunding, aggregation and digital wealth management. Fintech startups in the West are coming under more scrutiny to deliver profitable, scalable businesses; for example, a number of pioneering digital banks have ended up partnering with or being sold to big banks. Meanwhile, it is hard to make serious money without offering credit, which is a tricky proposition.

█ Payments will be a key battleground. The biggest single area of fintech investment over the past five years has been payments, which have accounted for over 25% of total spending. In China, the payments space is dominated by all!powerful internet companies (Ant Financial’s Alipay and Tencent’s WeChat), with banks relegated to the background. But things are – for now at least – quite different in the West, where cash and plastic cards dominate payments, and the four!way electronic payments infrastructure (merchants, acquirers, networks, banks) has been in place for decades.

█ The battle for the (digital) wallet. We are not convinced that the leading social media and internet companies (such as Facebook, Google, Apple, Samsung) want to actually replace banks – and thus invite upon themselves all the regulatory scrutiny, compliance and capital needs that banks are currently saddled with. But, for sure, payments are a natural extension of their business and the battle for the front!end relationship with the customer at the POS is heating up. Meanwhile, some banks are fighting back, such as JP Morgan with its Chase Pay and US banks owning ClearXchange, a P2P payments network.

█ P2P and online lending – the stuff of fintech dreams? A couple of the most interesting areas of fintech disruption have been P2P and online lending. These in many ways encapsulate the essence of fintech – using new technology to bring customers a faster, better value and more convenient service. From Lending Club, Prosper and Zopa, to Klarna, Quicken and Kabbage, new entrants are targeting aspects of lending that the established banks just don’t do well. But the P2P lenders have not yet been tested in a downswing, and some of the leading online lenders have ended up partnering with banks. Online mortgages are one area of significant disruption, with Quicken Loans now the second largest retail mortgage lender in the US.

█ Blockchain – (don’t) believe the hype? We briefly assess where we think blockchain technologies can make a difference in financial services, although, as the internet did not develop overnight, nor will blockchain. Blockchain will likely be developing in closed or permissioned networks. For asset



transfers, blockchains will need to be able to operate at high capacity, performing billions of transactions a day. We are starting to see some live applications, such as the UK’s SETL.

█ Digital currencies – genie out of the bottle. Digital currencies, of which Bitcoin is the most famous, are an offshoot of the digital economy and are here to stay. Finding the right path for regulating crypto!currencies is a challenge for regulators. Interestingly, some of them (in the US, UK, Canada and Australia) are already taking positive stance.

█ What fintech can mean for traditional branch banking. The development of digital channels inevitably presents a case for scaling down banks’ physical footprint, but in recent year branch numbers have actually been rising in many countries. The interesting case is Scandinavia, where over the last decade or so leading banks have cut branches by 45!60% with headcount reduced by 30%. This has led to a 25!30% positive impact on cost/assets. Given the intense pressures banks are under to cut costs and boost profitability, it looks to be just a matter of time until more banks globally follow this example.

█ Russia’s financial maturity – underbanked, but things are changing. Ten years ago, only a quarter of Russians were bank users. Now about 75% of adults are banked, although this is still low in an international context, meaning that there is still room for Russian banks to bring in new customers. The physical distribution network is quite well developed in Russia relative to other countries and branch numbers have already started to shrink. The ATM network is also well developed with 1.7 cash machines per 1,000 adults.

Payment cards, per capita

0

2

4

6

8

10

12

Chi

na US

Japa

nSo

uth

Kor

eaCa

nada

Braz

ilU

KN

ethe

rland

sSw

eden

Port

ugal

Turk

eyFr

ance

Den

mar

kA

ustr

iaG

erm

any

Sout

h A

fric

aR

ussi

aSp

ain

Italy

Cze

ch R

epub

licPo

land

Gre

ece

Hun

gary

Indi

a

Credit cards per person Other cards per person Source: IMF

Share of card payments in total card operations in Russia

7% 8%9%

13%15%

18%

21%

24%

28%

0%

5%

10%

15%

20%

25%

30%

2008 2009 2010 2011 2012 2013 2014 2015 1H16 Note: Including ATM cash withdrawals.

Source: CBR

█ Cash still king, but cards and mobile banking are on the rise. Although Russians still generally prefer to pay with cash, card usage has been consistently growing for several years, helped by the rollout of POS terminals network (including phone!attachable mobile POS devices) with the share of card payments in total card transactions increasing from 9% in 2010 to 28% currently. Every adult in Russia on average has more than two plastic cards now. Of this, however, credit cards are only 12%, meaning there is a lot of potential for growth, although, with Apple Pay having recently arrived in Russia, mobile payments are likely to start challenging plastic cards in the years to come.

█ The nuances of Russian fintech. Contrary to the way fintech has developed in the West, in Russia, some of the leading banks, such as Sberbank, Alfa Bank and Tinkoff, are doing some of the most interesting things to modernize financial services, and we provide extensive profiles of Sberbank and Tinkoff. Such areas as payments, microfinance and mobile acquiring offer some interesting players, which we profile in brief in this report. However, with the exception of the likes of QIWI and Yandex.Money, they are generally small scale. New digital banks are also starting to appear, trying to follow in Tinkoff’s footsteps of not relying on physical branches and focusing their offering on improving the client experience.



█ Sberbank ! Russia’s leading online banking platform. Sberbank’s online retail banking platform is the largest in Russia, with over 33 mln users. Growth is being increasingly driven by mobile, with mobile!only users increasing from 1.4 mln at end 2014 to 10 mln in 9m16. Sberbank has also built up an almost 60% share of the merchant acquiring market and has an over 40% share of the credit card market. It is modernizing its corporate online banking platform and also rolling out Evotor smart terminals for SME clients.

█ Tinkoff – one of Russia’s original fintech names. Tinkoff is almost a decade old and, having proved that a fully branchless model can work in Russia, remains one of the most successful fintech stories in Russia. Now it is looking to tap into its strong brand, leading online and mobile platforms and impressive lead generation and acquisition skills (5 mln active customers) to roll out an online financial supermarket with a combination of proprietary products and third!party brokerage, such as online mortgages. Another new business line is digital banking for SMEs, which seems to be a pretty hot new niche in Russia.

█ Moscow Exchange – a financial technology company at heart. Moscow Exchange has always been a financial technology company, as the exchange business is pretty demanding in terms of IT infrastructure. But it also has a unique business model, which in a sense implies some disruption of existing markets, for example, by providing access for retail and corporate customers to its forex market. We also look at how Moscow Exchange is responding to the advent of blockchain, including implementation of e!proxy voting for bonds.

SWOT analysis of the position of banks relative to potential fintech disruption

Strengths

! Client base. Large base of identified (full KYC) customers with cross!sell potential.! Infrastructure. Branch/ATM/POS infrastructure is largely built and easily accessible.! Trust. Population trust its money to banks that are backed by deposit insurance.! Barriers to entry. High regulatory and capital barriers keep newcomers away from banks' core risk!taking business.

Weaknesses

! Customer service. Traditional bank processes involve a lot of paperwork and mandatory branch visits, which is not convenient for the customer! IT systems are inflexible. This makes them hard to adjust in real time and to launch new products quickly! Tight regulation. Makes it hard for banks to think outside the box! Low capitalization of banks. May prevent investing in crucual technologies to survive

Opportunities

! Keeping last mile contact with client. Retaining client focus via launching tailored mobile apps, marketplaces, launching new services through open APIs.! Cost!cutting. Digital penetration can bring cost efficiencies with respect to closing down physical infrastructure.! Big data. Banks' access to important client transaction data can make them valuable partners for all retail businesses. ! Underpenetration. Banks may be among the most advanced institutions in Russia's underpenetrated markets, hence providing time and scope for retaining and broadening client base.

Threats

! Disintermediation. Rollout of direct market access and P2P lending (though banks in Russia have years before it may start really growing).! Loss of margin in traditional banking products. Banks' juicy commisions on FX and money transfers could be gradually eaten up by new platforms.! Becoming back end. New services like Apple Pay risk partially removing banks from client!facing communication.! Cybersecurity. Breaches can bring losses and undermine trust in banks.

Source: Sberbank CIB Investment Research



Introduction

In this report, we aim to lift the lid on the Russian fintech space. There is more going on than many would expect, but there are also specific characteristics and challenges to the development of fintech in Russia. There will be several different parts to this note:

█ Setting the fintech scene. In this section, we look at some of the main trends in the fintech space globally, focusing primarily on retail banking, and the implications of new technology for banks and how banking is being conducted.

█ Russia’s financial development. Here, we look at the main characteristics of Russia’s financial development, and how this compares with other countries.

█ Fintech profiles. We also look at what some of the more interesting players are up to, from banks such as Sberbank and Tinkoff Bank to stock exchange Moscow Exchange.

█ How fintech fits into financial services in Russia. We look at some of the characteristics of fintech in Russia, as well as the regulatory backdrop. We then take a look at some interesting fintech names across retail banking, from online banks and microfinance to POS lending and payment companies like QIWI and Yandex.Money.

█ Fintech interviews. Finally, we intersperse the report with interviews with a few leading figures in the fintech world. This includes Oleg Tinkov, the founder of Russia’s pre!eminent fintech, Tinkoff Bank; Brett King, a global fintech pioneer and Moven’s CEO, and, Irene Shvakman, the head of a couple of innovative Russian fintech startups. We think these interviews offer insight into some of the key issues in fintech at the moment and what could be in store in the space over the next decade or so.

We add the caveat that “fintech” has become a huge and rather all!encompassing topic of late, seemingly reaching every corner of the financial services and technology landscapes. We by no means set out to cover everything in this report. Instead, we see it as setting out the lay of the land, and focus primarily on front!end retail banking.

We expect it to be the first of a series of reports on this fast evolving and most exciting area. So, with that in mind, stay connected!



Setting the Fintech Scene

“Within 20 years, we’ll probably see the elimination of 40!50% of the household names in banking today.” (Brett King, founder and CEO, Moven)

“If you don’t have the relationship with the customer, you’re just a utility, you’re just the dumb pipes.” (Francisco Gonzales, executive chairman, BBVA)

Fintech – this time it’s different?

Fintech (an abbreviation of “financial technology”) is hot property at the moment. A look at VC and private equity financing shows total fintech equity financing surged in 2015 to $25 bln (according to The Boston Consulting Group, a leading management consultancy) and is on track to match or top that in 2016.

A look at more granular data gives an insight into those fintech areas most beloved by investors. Over the course of 2010!16, the biggest recipients of fintech funding have been payments (26%), peer!to!peer (P2P) lending, crowdfunding (20%), data and analytics (17%) and planning (16%). Blockchain, which elicits comparisons with the invention of the internet in terms of potential importance, has so far not received a material share of the pie, accounting for only 2% of fintech funding so far in 2016.

Fintech funding, $ bln

2.64.4 5.2

10.0

18.9

25.2

14.7

0

5

10

15

20

25

30

2010 2011 2012 2013 2014 2015 2016 YTD

Blockchain Data and analyticsInsurance Lending/crowdfundingPayments PlanningSecurity Trading and investments

Note: 2016 data is up to July 2016.

Source: The Boston Consulting Group

Breakdown of total fintech funding over 2010!16

2%17%

4%

20%

26%

16%

7%8% Blockchain

Data and analytics

Insurance

Lending/crowdfunding

Payments

Planning

Security

Trading and investments Source: The Boston Consulting Group

In reality, fintech has been around for the past 50 years or more, from the advent of ATMs and the card payment networks in the 1960s to the likes of the SWIFT electronic payment messaging system in the 1970s and the first online banks in the 1990s. It has been through periods of great excitement and accelerated change as well as quieter periods of little buzz. We are clearly in the one of the former phases at the moment. And set against this evolving backdrop has been the seemingly continuous presence of large, dominant banks – as well as prophesies of their impending demise.

SO HOW DIFFERENT IS THE EXPLOSION IN INTEREST IN FINTECH THIS TIME AROUND?

We think the current surge of enthusiasm stems from the simple premise that the rapid advance of technology now clearly has the world of financial services in its sights. And there’s money to be made in this. In some ways, financial services are coming rather late to the party of disruption through technology. While there has been a general process of modernization over the past several decades, many core banking products (such as savings and loans products), means of payment (cards and cash) and branch!led distribution are fundamentally little changed. By contrast,



industries such as music, publishing, telephony, and more recently, taxi services and accommodation booking, have all seen massive disruption over the past decade or so, driven by technological change that has been widely welcomed and adopted by consumers.

It may have taken some time, but new technologies are now starting to change the way many financial services and transactions are carried out, from the likes of mobile payments, P2P and online lending, to wealth management and aggregation. Recent years have seen a mass of new entrants across all areas of financial services trying to do things more cheaply, conveniently and efficiently than traditional models.

FINTECHS BEING VIEWED THROUGH A MORE CHALLENGING LENS

What is interesting, however, is that much of the talk over the past couple of years about fintech startups usurping banks has somewhat faded of late. Fintechs are now generally being looked at through a much more challenging lens, to a large degree because the number of game!changers that have built scalable and profitable businesses is not quite what was perhaps expected.

Alongside this, having been through first denial and then fear, big banks seem to be finally accepting that the impact of new technology on financial services is here to stay and that the time to act is fast passing. Hence, in many areas the terms of the fintech debate have shifted from ones of competing with and even usurping banks to collaboration with or even acquisition by banks, although this is by no means universally the case. The point is we seem to be at a stage where banks are starting to wake up to the need to change, although it is not clear how successful many will be given the internal challenges in terms of culture and IT systems, as well as continual pressure on costs.

We now set the scene in terms of the main areas of fintech disruption in retail financial services.

Digital banks – here to stay?

Across the globe, the past five years or so have seen an increasing number of digital banking startups (also known as neo!banks) that are looking to take on incumbent banks at the center of their customer relationship – traditional liability products such as bank accounts and debit cards. The main proposition of banks such as Moven, Simple, Fidor Bank, Number26, Monzo, UBank, Atom Bank, Nubank, Starling, mBank and others is that they offer fully digital (no branches), typically mobile!app led banking with innovative features (e.g. savings goals, spending habits, often tapping into better use of real!time data) and which eschew the hidden fees that have given retail banking a bad name. Ultimately, they aim to avoid looking like banks as we know them – on the premise that their mostly younger customers don’t want to deal with banks as they know them.

Some obvious advantages these new banks would appear to have over established players are technology!driven cultures, lack of legacy IT systems, lower acquisition and distribution costs thanks to not being weighed down by branch networks, an increasingly benign regulatory environment toward new entrants as regulators try to raise competitiveness in banking (such as in the UK), lighter capital needs (as many of these banks start out without offering credit), and not being tainted with the negative public attitude toward existing banks after many years of scandals.

An interesting report on digital banks was recently published by Frost & Sullivan. One observation is that incumbent traditional banks are now trying to act fast to introduce their own digital banks, or to acquire interesting start!ups and leveraging their client bases. Out of the eight largest direct banks by client base, only one is independent – Russia’s Tinkoff Bank with 5 mln clients. Neo!banks like Number26, Fidor Bank or Atom Bank are still quite small with client bases of 100!200k, though these are often growing fast.



Leading digital banks by client base Rank Name Type Parent Country No. of clients, mln

1 ING Diba Affiliated ING Group Germany 8.52 Capital One 360 Affiliated Capital One Financial US 7.83 USAA Bank Affiliated USAA US 74 FNBO Direct Affiliated First National of Nebraska US 65 Rakuten Bank Affiliated Rakuten Japan 56 Tinkoff Bank Independent – Russia 57 TIAA Direct Affiliated TIAA!CREF Trust Company US 3.98 Discover Bank Affiliated Discover Financial Services US 3.59 Alior Bank Independent – Poland 310 DKB AG Independent – Germany 3…23 mBank Affiliated BRE Bank/Commerzbank Poland 137 UBank Affiliated National Australia Bank Australia 0.441 Number26 Independent – Germany 0.2244 Fidor Bank Affiliated Being acquired by BPCE Germany 0.249 Atom Bank Independent – UK 0.1556 Simple Affiliated BBVA Group US 0.1…– Moven Independent Partnered with CBW Bank, TD Bank and Westpac US

Note: Moven was not included in the Frost & Sullivan report, likely because it is technically not a bank but a digital banking application

Source: Companies, Frost & Sullivan, Sberbank CIB Investment Research

WITHOUT CREDIT, HOW SUSTAINABLE ARE THESE BUSINESSES?

But we question the potential sustainability of these new entrants. Acquiring customers and offering a high level of personalization in the early days may not be so hard, but it gets progressively harder – and costlier – to attract new customers. This takes time and money, and a big factor is whether startup banks can generate sufficient scale and profitability before the funding runs out.

The difficulty of becoming profitable stems from the fact that most of these banks are making money from interchange (which is rapidly declining under regulatory pressure), interest earned on the funding kept with them (negligible nowadays) and, maybe, transactional banking fees, which is a low margin, high volume business. The real money in core banking activities (outside payments) lies in credit, and this is an altogether different and more difficult business to get right, not to mention more capital intensive. As a result, it is one that none of these new challenger banks are yet involved in, and it remains to be seen whether they can successfully make the transition.

THE DIFFICULTY OF GOING IT ALONE

A few case studies of pioneers among new digital banks are revealing.

█ Fidor Bank (Germany). Launched in 2009, it has about 100,000 account!holding customers in Germany, and a financial community of over 300,000. In July 2016, it was bought by France’s second biggest banking group, BPCE.

█ Simple (US). Launched in 2009. Having acquired about 100,000 customers, in 2014, Simple’s founders sold the company to Spain’s BBVA for $117 mln.

█ Moven (US). Launched in 2010, by contrast, Moven has retained its independence and has chosen the path of licensing its technology to partner banks, such as Canada’s TD Bank and Australia’s Westpac, which we think is a sign of how tough it is to build sufficient scale in the direct!to!customer business. Another interesting element here is Moven’s decision to partner up with other fintech providers, such as Payfix and CommonBond, which are credit card and student loan consolidators. This may well be a model for fintech companies, many of which operate in niche segments of financial services, to start creating digitally!driven financial “ecosystems,” for want of a better word.

The genie would seem to be out of the bottle in terms of new players offering a radically different approach to everyday banking, but there is no firm evidence yet that any of these names are seriously threatening the dominance of incumbent banks, and we think that should that time come,



large banks will either try to snap them up or partner with them. However, they certainly provide some crucial lessons to their larger peers about offering higher quality daily banking services.

Payments – the big battleground

“Payments will go through more technological change in the next five years than in the past five decades.” (Ajay Banga, CEO, MasterCard)

One of the biggest areas of disruption in financial services at the moment is payments, which is not that surprising given the potential rewards on offer for owning the customer relationship at the point of sale (POS). We will look at the P2P payments space a bit later, for now we focus on digital payments in commerce.

CHINESE LESSON

One of the quotes we opened the chapter with came from a senior BBVA manager commenting that if banks don’t have the relationship with the customer, they risk being relegated to being “the dumb pipes.” China offers an extreme example of how this can ultimately play out, although the characteristics of the Chinese market, with its online commerce powerhouses and weak banks, are not (for now at least) matched in the West.

In China, the digital payments market is dominated by the e!wallet offerings of the country’s leading internet companies, Alipay (owned by Ant Financial, a spinoff from Alibaba), and Tencent’s WeChat. These companies also dominate the offline payments market, such as through the popular medium of QR code contactless mobile payments. Chinese banks are still involved in the payments process, given that the main way of loading up an e!wallet remains through linking it to a bank account (hence they still earn interchange), but banks have pretty much conceded the customer!facing payments space to the online business giants, and the likes of Yu’e Bao, AliPay’s money market fund, have also been eating into banks’ deposit bases.

DIFFERENT IN THE WEST

But things are very different in developed Western markets:

█ Cash and plastic cards still overwhelmingly dominate payments. According to Euromonitor, only 15% of retail transactions in the US in 2014 were paid for by electronic means, 46% used cards, 25% cash and 14% other paper means (such as checks).

Retail transactions in the US by payment category

15%

46%

25%

14%

Electronic

Cards

Cash

Other paper

Note: Data for 2014.

Source: Euromonitor

█ The essential core of the payments infrastructure (merchants, acquirers, networks, banks) has changed little in several decades and generally deals smoothly with processing massive volumes of transactions. It is an oligopolistic, low margin, high volume business, with high barriers to entry.



█ The emerging digital payments space is highly fragmented and competitive, with new entrants seemingly struggling to achieve scale and with making the transition from their core businesses to becoming the POS payment provider of choice.

█ There is no clear uniformity on technology: big differences exist between markets, such as the US and Europe.

HOW ARE THE NEW DIGITAL CONTENDERS FARING?

In the digital payments space, the battle lines are being drawn. This includes seemingly powerful new entrants such as Apple Pay, Samsung Pay and Google’s Android Pay, the incumbent e!wallet leader PayPal, leading retailers such as Amazon, Starbucks and Walmart, the established payment networks (Visa’s Checkout and MasterCard’s MasterPass) and leading banks, such as JPMorgan Chase’s Chase Pay. All of these players are competing to be the primary electronic payment mechanism for customers, with mobile likely to be the key battleground.

Leading US digital wallet providers

Owner Owner's industry Launched

PayPal Finance 1998

Amazon Online retail 2007

Starbucks Retail 2011

MasterCard Finance 2013

Visa Finance 2014

Apple Electronics 2014

Google Internet 2015

Samsung Electronics 2016

Walmart Retail 2016

JPMorgan Chase Banking 2016

Source: Companies, Sberbank CIB Investment Research

Most popular digital wallets in US as of end 2014

79%

18%

16%

11%

7%

6%

6%

3%

2%

2%

1%

1%

1%

1%

1%

1%

0%

0% 20% 40% 60% 80% 100%

PayPal

PayPal Credit

Amazon

Starbucks

Google Wallet

iTunes

Visa Checkout

Dunkin' Donuts

Serve

Apple Pay

Samsung Wallet

MasterPass

Bitcoin

Square Order

Softcard

LevelUp

CurrentC

Source: Statista, comScore

However, to date the take!up of new payment contenders seems to have been slow going, and we think that taking on the incumbent banks and PayPal is not going to be easy. We note that a company with all the power of Apple has decided to launch Apple Pay through partnering with the existing infrastructure players (banks and networks), albeit it is demanding about 10% of the bank interchange and will surely try to eat into it further if and when payment volumes through Apple Pay pick up. Mobile networks that several years ago were promising moves into payments have also failed to make any headway.

With the strength of its brand, customer base and iTunes payments background, Apple Pay may well emerge as a major player in the long term, but it is early days and so far the company has given virtually no data about take!up. Meanwhile, Google seems to have so far struggled with its payments systems and has rather awkwardly split them into two: Google Wallet for P2P payments and Android Pay for e!commerce. It has the obvious advantage in data, but that doesn’t necessarily translate to a popular payment tool. Samsung Pay, which in theory has a higher potential merchant base, given it works with both near!field communication (NFC) and magnetic secure transmission (MST, i.e. magnetic strips on cards), is now available in eight countries, but again we have minimal data on usage.

PayPal is the king of e!wallets in the West and currently the biggest rival to banks in terms of owning the customer relationship at POS. It has been around for almost 20 years and with over 180 mln active users (by active they mean at least one use in the past 12 months). We think it has a strong



and trusted brand and should remain a serious player, helped by acquisitions such as Venmo, a leading P2P company. By contrast, we think merchants may be wary of embracing Amazon’s payment system given that it is still viewed as a competitor.

As for the likes of Visa and MasterCard, who themselves are branching into e!wallets, we are not convinced they can make the leap from being the infrastructure backbone to the customer!facing front end. The Starbucks app is one of the most successful mobile payment apps in the US, which suggests that consumers may well use different payment vehicles for different services. Meanwhile, social media giant Facebook is for now focusing on P2P payments in this space, which sits more comfortably with its core business. There is, it seems, still much to play for.

END OF THE CARD?

So does the emergence of mobile payments spell the end for the plastic card? And what would that mean for the banks and payment networks that have underpinned the payments system for decades?

We think that plastic cards will remain with us for a while to come, given their still dominant position in Western payments. Moreover, NFC makes the card payment experience much more convenient and should boost usage in the near term. In the UK, for example, the number of NFC!enabled contactless payments (the vast majority of which are with cards) has risen more than tenfold, from 18 mln in March 2014 to 240 mln in July 2016, and contactless payments now account for almost 20% of card transactions.

UK contactless payments

0

60

120

180

240

300

0

500

1,000

1,500

2,000

2,500

Mar

’14

May

’14

Jul ’

14

Sep

’14

Nov

’14

Jan

’15

Mar

’15

May

’15

Jul ’

15

Sep

’15

Nov

’15

Jan

’16

Mar

’16

May

’16

Jul ’

16

Spending on contactless cards, GBP mln per monthNumber of contactless card transactions per month, mln (rhs)

Source: UK Cards Association

Breakdown of consumer payments in US by type, number of transactions, bln

38% 40% 41% 42% 44% 46%

13% 13% 13% 14% 14% 15%27% 27% 26% 27% 26% 25%22% 21% 19% 17% 16% 14%

0

2

4

6

8

10

2009 2010 2011 2012 2013 2014

Card payment Electronic direct/ACH Cash Other paper payment

Source: Euromonitor

However, looking out, say 10!20 years, it seems entirely plausible that plastic cards will be replaced by virtual cards. John Stumpf, who recently stepped down as Wells Fargo’s CEO, once commented: “We’ll probably be the last generation to use the term credit card and debit card… it will probably be debit access or credit access and it will be loaded onto a mobile device.”

The key aspects for payments from a customer perspective are convenience and security. Both providers and merchants will ultimately have to adapt. On the former, we think it will take some time for people to feel comfortable with contactless smartphone payments. On the latter, advances in technology such as the advent of secure tokenization (which essentially substitutes the payment details on a card with a randomly generated code), biometric authentication and enhanced encryption suggest fraud is likely to be much less of an issue for mobile phone payments than for plastic cards.

WHAT ABOUT THE BACK END?

Could banks and payment rails be cut out of digital payments? This seems unlikely to happen any time soon, as highlighted by the example of Apple’s stance on its payments rollout. There are, however, some interesting companies looking to shake up the existing system. For example, in the US, Dwolla



has developed a payment mechanism for SME merchants that bypasses the traditional payments infrastructure, charging instead a flat fee on transactions above a certain amount. The proposition to merchants is that they are being excessively penalized by the all!powerful existing payment infrastructure, which typically takes 2% or more of credit card transactions. The idea seems a good one, but the problem here is surely going to be one of obtaining sufficient scale in such a low margin business. Merchant Customer Exchange (MCX), created by a group of leading US retailers, had also been hoping to develop a payments solution that would bypass the card networks, but the project has run into difficulties (not least because its most powerful member, Wal!Mart, is looking to develop its own payments system). MCX is now focusing on bank partnerships.

But the threat to banks in the payments space is clearer, as they risk being disintermediated in a few ways:

█ Losing the front!end payment relationship with customers. The jury is still out on this and some banks are not standing still. JPMorgan Chase, for example, last year launched its Chase Pay e!wallet for its 90+ mln cardholders.

█ Declining interchange. This can stem both from regulatory pressure (such as changes made in the EU last year capping interchange at much lower levels than before) and from emerging payment providers demanding a cut.

█ Customers loading funds directly onto e!wallets, such as salaries, thus bypassing banks. We do not see a major risk over the next five years.

TECHNOLOGY STILL FRAGMENTED

The picture is also clouded by the lack of uniformity about underlying payment technologies. NFC is taking off in many countries and may over time receive a boost from its adoption by Apple Pay, while QR is a popular technology in China. But, strangely, the US seems behind the curve on digital payments, with October 2015’s EMV (Europay, MasterCard, Visa) liability shift driving a move from the dominant plastic card magnetic strip means of payment to chip!enabled cards being put into an electronic reader which does not necessarily also offer NFC. In the US, the onus is on retailers to update their payment systems, so the short!term incentives are clearly distorted, but the relative inertia has enabled sharp new entrants like Square to establish a foothold in the space, although even Square’s core hardware solution is a card!based swipe system.

P2P payments and money transfer – ripe for change

The other area of payments being transformed by technology is P2P payments, both domestic and cross!border. There is a clear market opportunity here for the simple reason that the current systems of transferring money between people are often slow, inconvenient and costly. Traditional bank!to!bank transfers still often take up to several days.

No discussion about P2P payments gets very far without reference to Kenya’s groundbreaking M!Pesa, which is almost a decade old now and which transformed Kenya’s financial services landscape by offering simple P2P money transfers via mobile phones (not smartphones). Impressive as it is, this story was largely about tapping into a clear market need (where there was a lot of financial exclusion) using existing technology, and we have since seen similar mobile!based payments services launched in many emerging markets in which the share of unbanked population is high. In Russia, Sberbank has for several years operated P2P mobile payments for its customers. The service is very popular, with almost 20 mln users, given its convenience (you just need a mobile number) and the widespread use of Sberbank bank accounts in Russia.

In the US, Venmo (acquired by PayPal in 2013) was one of the first companies to successfully launch a real!time P2P payment service, allowing people to link credit and debit cards online (or use



funds in Venmo’s e!wallet) and transfer money instantly to one another, with payment details encrypted. The service is free for transfers from a bank account and costs 3% from a credit card. Funds can be sent with just the email or phone number of the recipient, although the recipient needs to open a Venmo account to access the funds. However, PayPal’s recent deal with Visa enables users to instantly access funds received via bank accounts. Square came out in 2014 with its own real!time payment service in partnership with Snapchat, called Snapcash.

SOCIAL NETWORKS JUMPING ON BOARD

Leading Asian messenger services like China’s WeChat and Japan’s Line are well ahead of the game in the P2P payments space. Western social media companies, by contrast, are only really starting to get their acts together as they realize that P2P payments are a natural extension of their existing social platforms and messaging services. Facebook is rolling out P2P payments through its messenger app service, while WhatsApp and Twitter are both starting to team up with banks to facilitate payments and Google is offering P2P payments through Google Wallet and Gmail. Apple is also looking at this market through its Siri digital assistant.

In the US, however, the big banks still dominate P2P payments. For example, JPMorgan’s Chase QuickPay processed $20 bln in P2P payments in 2015 (compared with Venmo’s $7.5 bln), but until recently these payments were still slow. Although it took US banks some time to wake up to the need to roll out more convenient, real!time payment services, there is now clear progress. Many leading US banks have signed up to Early Warning’s ClearXchange venture, which now offers real!time, bank!to!bank P2P payments. Bank of America, JPMorgan Chase and US Bank were among the first to go live earlier this year.

The UK is well ahead of the game in this respect, as a consortium of banks launched Faster Payments Service (FPS) in 2008, enabling real!time P2P payments between participating banks. Barclays was one of the first banks to launch its own proprietary mobile app!based P2P payments service, Pingit, in 2012.

INTERNATIONAL PAYMENTS RIPE FOR DISRUPTION

The international payments or remittance market is, if anything, even riper for disruption given that the fundamentals of international payments have changed little in decades, resulting in a system that is typically inconvenient, costly and slow.

A number of new digital entrants are now trying to shake up this business and drag it into the digital age. Companies such as TransferWise, Earthport, Azimo, Currency Fair, Xoom and WorldRemit have all come out with money transfer systems that aim to make such operations faster, cheaper and less painful. These new players innovate in different ways, such as offering current exchange rates without mark!ups, matching buyers and sellers of currencies so there is no need for any cross!border currency movement, or using funds from the various bank accounts they have in different countries. TransferWise, for example, claims to be up to eight times cheaper than an average bank, although it still says that transfers will take from 1!4 working days. Meanwhile, Earthport specializes in business money transfers and works with local banks and clearing houses in over 60 countries. It states that payments are typically received within a day, with the recipient receiving exactly the sum sent. It signed a strategic alliance with Bank of America in 2014.

While there are clearly interesting innovations here, questions remain about the sustainability of these new businesses given that with low margins, this needs to be a high volume business. Ultimately, Earthport’s alliance with Bank of America may signal the most realistic strategy here. Also, the fully online nature of these new services suggests that it will take some time for them to eat into more cash!based EM remittance businesses of global money transfer giants like MoneyGram and Western Union.



P2P lending – the stuff of fintech dreams?

The emergence of the P2P online lending market appears to be the stuff of fintech dreams. Technology now allows for the creation of online marketplaces that match borrowers and lenders, offering better terms for individuals and SMEs struggling to access affordable credit. By the same token, for those with some savings they want to invest, it also offers superior returns in an ultra!low interest rate environment, depending on risk appetite. It would seem that everyone’s a winner, apart from banks, which are effectively disintermediated in the process (although they can act as intermediaries issuing the credit).

The technology angle encompasses a speedy and convenient way of bringing lenders and borrowers together online – and these marketplaces don’t have to bear the high cost of bricks!and!mortar lenders. In terms of credit risk, many of these platforms claim to use proprietary scoring models based on more diversified credit risk analytics than traditional bank underwriting, including social media, web usage and locational data. The credit risk is typically carried by the lenders rather than the marketplaces, so individuals and institutions can buy slices of loan portfolios diced up according to credit risk appetite. Revenues are generated by transaction, loan service, borrowing, management fees and the like.

So how big is this P2P market and how are the credit risk/returns? In the UK and US, the leading eight players combined intermediated $23 bln of loans in 2015, according to Liberum, an investment banking boutique. In the US and UK, marketplace lenders typically account for 1!2% of the segments they are operating in, so, while the growth has been very rapid, the numbers are not material compared with total loan volumes (over $8 trln in the US, for example). It is harder to access the credit risk and returns, but according to Liberum, yields globally average 5!9%; Lending Club (LC) for example projects annual returns at 5!8%, which is clearly a much nicer yield than the average savings account.

Lending Club volumes relative to US consumer credit market, $ mln

0.0%

0.1%

0.2%

0.3%

0.4%

0

3,000

6,000

9,000

12,000

2012 2013 2014 2015 1H16

Originated with LCLC servicing portfolioLC portfolio as % of US consumer credit outstanding (rhs)

Source: Company, Federal Reserve, Sberbank CIB Investment Research

Online P2P lending annual volumes as % of addressable market (as defined by Liberum)

11.5%

2.2% 1.7%

0.1%0%

3%

6%

9%

12%

15%

China US UK EU ex.!UK Source: Liberum

The likes of Zopa and Funding Circle in the UK, and LC and Prosper in the US (China is the other big market globally, with thousands of firms targeting borrowers that the big state banks do not service) started life as P2P marketplaces in the strictest sense of the word, but a number of different models have emerged spanning various funding sources, from individuals to institutions, and targeting different borrowers, from consumers to small businesses. Some platforms also take some balance!sheet risk themselves. According to data provider AltFi, in 2015, US P2P platforms received 20% of their money from retail, 50% from buy!and!hold institutional investors and 30% from securitizations, which shows this market has already shifted away from being a pure P2P marketplace. There are now dozens of P2P lending platforms in the market, filling many niches. One example is SoFi in the US, which was set up by former Stanford students and made a name for itself by matching student funding needs with alumni.

In the US, LC became a poster child of fintech when it IPO’ed in 2014 with a $5 bln valuation. The stock has had an awful past year or so, more than halving in value following some corporate



governance related problems, but the company does at least continue to post strong growth (it has funded over $20 bln in loans to date) and has been increasingly profitable over the past three years.

REGULATORY SCRUTINY MAY RISE

But LC’s problems combined with the very rapid growth of this space do highlight the fact that regulators are likely to start scrutinizing these businesses much more closely. Currently, many P2P marketplaces enjoy light regulation and low capital requirements, given that they are not themselves carrying credit risk, although the disclosure provided to potential lenders could often be improved. What’s more, given the increased sophistication of this market, with securitizations and wholesale money, regulation could become more restrictive to avoid any potential subprime!like credit bubbles.

P2P lending is a segment of the financial services market that appears to be here to stay, and regulators typically seem to welcome its ability to intermediate credit in areas that banks are just not adequately servicing. However, it is very hard to gauge how resilient these businesses may prove to be, given that they have been building scale during a benign part of the credit cycle, and one in which interest rates have been consistently low. The models have yet to be tested in a downswing.

Crowdfunding

While P2P lending disrupts banking credit, crowdfunding is the buzzword for new platforms disintermediating investors and businesses that want to grow or launch new products and seek funding for that. This serves as competition to VC angel funds and, in some ways, even public equity. This is a fast!growing market, almost doubling each year and, according to Massolutions, reached $16 bln in 2014.

There are two main types of crowdfunding – reward!based and equity!based. Reward!based crowdfunding is a way for a company to get money in advance for launching a new product on the market, with a discount offered to the backers relative to the future retail price. This has been used for a wide range of products – from consumer electronics to scientific research and movies. Examples of such platforms would be Indiegogo (launched in 2008) and Kickstarter (launched in 2009).

Equity crowdfunding is in direct competition with VCs, as in this form the backer receives a stake in the backed company. There is more regulation of this type of marketplace, however. In the US, for example, SEC regulation is required. Popular US equity crowdfunding platforms are AngelList and CircleUp.

Online lending – new players emerging

This is an area that in many ways ties in with developments in digital payments and P2P lending, particularly in online POS. The ability to migrate much, even all, of the credit process online – from product search, applications and KYC/AML to credit risk underwriting, loan issuance and repayment – has spawned a raft of companies looking to take advantage of lower acquisition and distribution costs, faster approval and issuance, more accurate underwriting through more sophisticated data crunching, better service and often better rates, given lower overheads than traditional lenders.

Below we highlight a few of the interesting areas, focusing on retail and SME.

█ POS credit. One of the most successful and pioneering online POS providers is Sweden’s Klarna, which, over the course of a decade has built up a business operating in 18 countries, with 45 mln customers and 65,000 merchants. Klarna aims to facilitate online shopping by offering a very convenient, easy!to!use online interface at the point of purchase with a minimum of fields to fill in. It also acts as a merchant acquirer. But the most interesting part of the business is the “buy now, pay later” financing it can offer, which means the customer doesn’t need to enter payment details, can receive and see the goods before paying and pays no interest if payment is made within 14 days (i.e. the customer pays just the face value of the goods). After 14 days, the credit



becomes a monthly installment loan at about 19% APR. The merchant receives the funds upfront from Klarna, which bears the credit risk. What’s in it for the merchants is the prospect of more checkout conversions. So the key here is Klarna’s ability to effectively crunch data to underwrite very fast credit at checkout. So far it seems that Klarna has built a profitable, sustainable and now sizable business, using technology to provide a convenient new angle to shopping online.

█ Small business lending. Small business lending is an area ripe for potential disruption, given that it is often neglected by large banks, and for which offline credit processes can be laboriously slow. Stepping forward have been the likes of Kabbage and OnDeck, which aim to use technology to remove a lot of the pain of borrowing for SMEs. They offer online applications, mobile apps, fast approval times (including very short!term working capital finance facilities) and promise no hidden costs, while using real!time data analysis at the back end. Again, the innovative use of data in credit risk solutions seems to be important here, drawing on a range of sources including social media interactions and feedback. For Kabbage, the credit application provides it with access to information about a merchant’s online sales, bank account, UPS and social media activity. The turnaround time can be as quick as a matter of minutes. OnDeck offers rapid financing decisions based on analysis of the financial performance of a company, including cash flows and corporate bank accounts, rather than the owner’s credit history. What is informative here is that both of these companies have partnered up with large banks – Kabbage with ING, and OnDeck with JPMorgan, which, as banks come to recognize the threat posed to them, again raises the question about the standalone sustainability of these kinds of businesses.

█ Mortgages. As with SME lending, a new breed of online mortgage lenders is looking to make the process far less painful and time!consuming for customers, and is gaining market share helped by offering very competitive rates in a price!sensitive market, which is possible given a lack of physical infrastructure. In the US, companies such as Quicken Loans, Roostify and Freedom Mortgage are taking a substantial share of the mortgage origination market as large banks increasingly scale back their businesses to ease capital pressures. Mortgages are often portrayed as a complex product – not least by those acting as middlemen in the process – but really they have the same core credit components as other loans, just for a far higher sum. Offline mortgage applications can be fairly painful, and the benefits of removing a lot of this friction are apparent in the market share being grabbed by new players. For example, Quicken Loans has closed over $200 bln of mortgage volume in 2013!15, and is now the second largest retail mortgage lender in the US.

Ultimately, the key elements for success in online lending include offering something radically different and more convenient for borrowers (such as we see with Klarna), and using the advantages of technology to speed up and reduce the cost of credit processes. Finally, having the ability to think about data in innovative ways and being able to successfully crunch vast amounts of “unstructured” data are crucial for getting the all!important underwriting right.

Looking out over the next decade, the winners in the online credit market are going to be those that can successfully embed real!time credit in shopping and other life activities, such as matching the need for a loan with a pre!approved facility.

Digital wealth management – tough going for fintechs

Another area of fintech that has generated a lot of noise is the realm of digital wealth management (also known as robo!advisory) services through companies such as Nutmeg in the UK and Wealthfront and Betterment in the US, as well as many others across a wide spectrum of digital advisory services.

The premise of these companies is that they can package online wealth management and advisory services to digitally savvy clients using proprietary algorithms to generate investment portfolios based on risk appetite, and that, without the whole offline active fund management apparatus, they



can do this at a much lower cost to the customer. These business models are also facilitated by the rapid rise of passive fund management and ETFs.

TOUGH MARKET TO SUCCEED IN

But fund management is a high volume, increasingly low margin game dominated by big global players with deep pockets, and while it is likely that some of the online disruptors will survive long enough to build sufficient scale, we imagine that there will also be a lot that fall by the wayside. Nutmeg, the UK’s robo!advisory pioneer, has posted increasing losses over the past three years, does not disclose its AUM and has recently dropped its highest fee to below 1% (to 0.95% for sums up to GBP25,000, excluding fund fees) as price competition intensifies.

Nor has it been easy for the market leaders in the US to generate scale. Between them, the three leading US companies, Betterment, Wealthfront and Personal Finance, have somewhere north of $10 bln AUM, well below the $30 bln or so for Vanguard’s similar digital wealth offering and a drop in the bucket in the US retail fund management industry (AUM of about $18 trln at end 2014, according to the Investment Company Institute’s 2015 Factbook).

While online processes and the use of investment algorithms can cut out a certain portion of the costs borne by offline active fund managers, there are still a decent amount of inbuilt fixed costs in terms of building secure and compliant platforms. Furthermore, in a competitive market, marketing spending is likely to be high. Big wealth management companies, particularly those with sizable ETF platforms (such as Blackrock) could well emerge as a major challenger to digital wealth managers. Private wealth management giant UBS has itself recently unveiled plans to launch a UK!based digital wealth management service.

Aggregation and personal financial management – waiting for PSD2

COMING BACK INTO FASHION

Back in the early 2000s, account aggregation was a hot topic in the UK, with the likes of Egg, Citibank and moneysupermarket.com launching aggregation services of one sort or another, typically using screen!scraping technology. But account aggregation never really took off over the next decade or so. This was due to a combination of reasons, from regulatory data protection issues about sharing data, to banks showing no inclination to share, and customers appearing to have little interest in this service.

Approaching 2017, account aggregation, and more broadly personal financial management (PFM), are once again hot topics in the fintech space. There are some key reasons why this service may have some staying power this time.

█ Technology. Real!time API plug!ins to accounts are now enabled if permissioned by the customer. Also, far more people now use online banking.

█ Regulation. In both Europe and the US, regulators are looking at ways of breaking down the oligopolistic structures of retail financial services, and one of the key means is through the encouragement of “open banking.”

█ Customer appetite. With the rise of mobile banking and desire for more simplicity and convenience in financial services, there may well be more appetite among consumers now for services that can condense their financial positions into one clear picture.

In the US, where there are no specific provisions relating to access to accounts, several online aggregation and personal financial management firms have been launched in recent years, including Mint (which was bought by Intuit for $170 mln in 2009) and Quicken (personal finance software) and MaxMyInterest, Capital One’s Wallet, as well as back!end providers such as Yodlee and Geezeo.



In terms of scale, Mint is well ahead of many, with over 20 mln users. It is profitable, with its main source of revenues coming through lead generation for third!party financial service providers. Its nearest UK peer would be moneysupermarket.com, although Mint offers more financial advice and tips, while the latter’s focus is on comparison.

PSD2 TO BE THE GAME CHANGER IN EUROPE

In Europe, the Payment Services Directive 2 (PSD2) which comes into force at the start of 2018 is likely to be a game changer.

The essence of PSD2 is to regulate third!party providers (TPPs) in the financial space, while increasing customer protection. It will lay out the ground rules for TPPs to access account data from banks and other account!holding companies if given explicit customer consent. From a technical perspective, banks will be required to build application programming interfaces (APIs), which essentially allow different software applications to communicate with each other and exchange data directly, without the need for human input. APIs have become the industry standard for sharing data.

The opening up of account information and financial histories will of course be a massive boost for the financial aggregation and PFM industries and should enable them to offer provide far more personally targeted financial advice and offerings than is currently the case. However, it has implications way beyond this, particularly in payments and credit scoring/rating, and also in building financial ecosystems that can include commerce and payments.

But does the opening up of account data simply spell bad news for banks? Not necessarily. For one thing, banks could of course be at the heart of aggregating data and offering more ecosystem!style financial services. In this area, trust is crucial and banks generally still have an advantage in this regard. But clearly it will mean they will need to move fast in order to limit the risks of disintermediation. France’s Credit Agricole, for example, already runs a virtual marketplace based on API plug!ins (CA Store), which offers customers both financial and lifestyle apps. In the UK, several leading banks are members of an open banking working group.

Technological innovation – blockchain

“Distributed ledger technologies…have the potential to disrupt the whole economy, and society.” (UK Government Chief Scientific Adviser)

The amount that has been written about blockchain over the past couple of years could probably fill a virtual Bodleian Library. Here, we briefly focus on what we see as the main advantages and disadvantages of distributed ledger technology (DLT), before looking at some possible applications of blockchain in the financial services space.

First off, what is blockchain, or DLT? A distributed ledger is, according to an excellent UK Government Office for Science report, “an asset database that can be shared across a network of multiple sites, geographies or institutions.” What makes it special is that all participants have their own identical copy of the ledger; it is almost instantly updated across all copies when a change is made; and its decentralized nature makes it cryptographically secure and very hard to corrupt. Distributed ledgers are essentially databases made up of chains of blocks, hence the term blockchain. Blockchain technology of course underpins the digital currency Bitcoin (more on that later), but here we are referring to its use within permissioned networks.



The pros and cons of blockchain Advantages Disadvantages

Distributed – a single shared ledger on which participants see the same version, rather than multiple data sources.

Lack of standardized protocols – competing formats such as those from Hyperledger and R3.

Secure – cryptographic verification using digital signatures. As the same copy of the database is distributed among participants, it is hard to attack/corrupt, there is no single point of failure.

Immutabiliity and the lack of a single point of failure can also be negatives, given the capacity for errors and potential difficulties in quickly obtaining consensus to correct.

Immutable – very hard to corrupt. All participants in the network will see if changes are attempted.

Legal framework – no universally agreed regulations, very complex given distributed nature of the technology.

Efficient and transparent – permissioned changes are instantly seen by all participants. Every participant (node) verifies transactions.

The potential scalability has not yet been widely proven.

Applicable to a wide range of industries as a more sophisticated form of ledger.

Questions over speed – given potentially complex cryptographic signature verification.

More than just a database – in combination with smart contracts can include rules and in!built execution of transactions.

Involves a radical overhaul of IT infrastructure and security – moving away from perimeter security to protection of private keys.

Potential cost savings – hard to gauge at this stage, but does at least allow for costs of building/maintaining to be shared amongst participants.

Political/philosophical elements of decentralizing or distributing systems will pose challenges.


SLOW BURNER

We recognize that there seems to be a lot more “talk than walk” with regard to blockchain, but as with any major infrastructural change, its evolution is inevitably going to be far from a straightforward process. A blockchain expert we spoke to in preparing this report likened its development to that of the internet, which has evolved into the vast distributed platform it is today over many years, although we would say that while the internet is unpermissioned, or fully public, blockchain development for commercial purposes will be almost entirely permissioned – meaning, it will be managed within agreed user groups. Nevertheless, it still seems to us that DLT is without doubt here to stay, even as there are numerous issues to be resolved along the way, from the technical capabilities of different platforms, to regulatory and jurisprudential matters, to rethinking core business concepts of ownership of information, trust and digital security.

So where are some of the most promising areas of application relating to financial services? As we see it, this would include areas of finance and business perhaps in which there is limited trust and for which having a single shared source of truth would benefit many different participants, or for direct P2P asset transfers that cut out third parties.

█ Asset transfers, such as securities. This is an area that has received a lot of attention, in part because of the obvious costs and inefficiencies in post!trading processes in many securities markets. While the trading itself often comes down to nanoseconds, post!trading can often be measured in days. There may also be a lot of different participants involved, from buyers and sellers, to brokers and custodians, exchanges and clearing and settlement providers, all of whom in one way or another keep their own records of transactions. There seems to have been genuine progress in blockchain solutions for asset transfers, such as securities. In researching this report, we spoke to Peter Randall, CEO of SETL (and founder of Chi!X exchange), which already has several commercially live blockchain projects. He said that to achieve success in financial services, blockchains need to fulfill five key criteria:

` They have to be able to operate at high capacity, which means processing tens of thousands of transactions per second.

` Following on from this, they need to be able to process billions of transactions a day, meaning that mining (as is the case with Bitcoin) won’t work.

` They need to be able to conduct KYC/AML checks, so they need to be permissioned.

` They need to be able to move real!world assets, such as cash and securities.



` They need to be able to talk to other blockchains, as there won’t be just one standard.

█ Identification/registries. This area seems to tick many of the boxes, touching upon aspects for which different parties could be interested in being able to access a secure shared database, and where there may be little trust or the potential for fraud. This can span a wide range of topics, from KYC/AML to registration of assets and auction processes.

█ Trade finance/supply chain management. This would also seem to fit the bill well. This would allow a number of different parties to a transaction, including banks, buyers, sellers, logistics companies, maybe even customs, to all be able to share a single common database. The magic here would be in incorporating smart contracts, which are effectively just a pre!written code that sets out the rules for a transaction and is executed by a network of computers, after which the ledger is updated.

█ Cross!border payments. Among the most financed DLT startups is Ripple, which is developing cross!border payments and has completed a number of pilots with commercial banks, although this remains at the testing stage.

█ Accounting and record!keeping. Although this is perhaps more for intra!company operations, the potential for streamlining and reconciling accounts and records internally, with clear potential cost savings, is enormous.

What are the potential implications of the emergence of blockchain for banks? It’s still early days and so far it appears that blockchain has primarily been developing in non!core banking transactions, like information exchange, registries and account keeping and trade finance facilitation – areas where there is a lack of trust and processes are not automated. In our view, it will take some time for blockchain to deliver the necessary level of security and speed in core financial areas like real!time payments and securities trading, although the case of SETL shows that things can move fast. Generally, we see more potentially positive implications than negative for banks, led by the prospect of material cost savings in areas such as compliance, trading and settlement and cross!border payments. But it is still way too early to have any clear sense of the scale.

Technical innovation – big data

As with blockchain, barely a day passes in the world of fintech when we don’t hear about “big data” and why everybody needs it. But what does this actually mean?

Big data refers to working with data sets that are too large for traditional processing methods. Within the world of commerce or banking, this is really about mining digital data to better understand customer behavior. This is hot right now because there is a lot more data out there these days that requires new approaches to processing, and there is also a lot more competition to understand and benefit from consumers’ online behavior.

One of the most noteworthy (and pretty mind!blowing) statistics that we have come across in researching this note is IBM’s guesstimate that 90% of the world’s data has been created in the past two years, and that we now produce 2.5 quintillion bytes of data (that’s 2,500,000,000,000,000,000 bytes) per day. However, on the plus side, the cost of computer power has fallen dramatically over the past decade, as has the cost of storage since the advent of cloud computing.

Big data analysis typically breaks down into two main groups – structured and unstructured data. The former group is data of typically clearly defined format and length, often stored in a digital warehouse of some form, such as bank account statements or payment transaction histories. Generally, it is easily searchable with simple algorithms. The other much larger and newer group refers to the ever!increasing mass of “noisy” data that is available on the internet and social media, such as searches, messages, GPS data, which is much more difficult to manage and process.



SO WHO’LL OWN THE DATA?

In this world of digital commerce, the oft!repeated phrase is that whoever owns the data will win. So who is best placed in this area? The first group of companies that typically comes up when big data winners are discussed is search engines such as Google and social media sites like Facebook. These two businesses (and others like them) first find out that you plan to go on holiday when you start searching online, or when you start telling your friends on social media. The bank, meanwhile, only realizes it when you use your bank card to book your trip or perhaps even only when it rejects a cash withdrawal at a bazaar in Marrakech on suspected fraud! In theory, this of course gives the internet/social media companies an obvious advantage in areas such as predictive analytics, targeted marketing and, ultimately, possibly in payments.

But banks have traditionally been pretty data!intensive companies, although a problem as far as we see it is that data in big banks is often siloed. Nevertheless, banks have some pretty useful financial data on their customers that these non!banking companies don’t necessarily have, although there are big challenges to banks in the payments space, and more broadly from the opening up of account information that we will see with the likes of PSD2 in Europe.

Ultimately, how this plays out will depend to a large degree on the extent to which the really “big” data companies want to encroach on the banks’ turf.

Digital currencies – genie out of the bottle

“The root problem with conventional currency is all the trust that's required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust.” (Satoshi Nakamoto, Bitcoin founder)

Distributed ledger, or blockchain, technology of course first found fame in the form of Bitcoin, a digital currency that was formed in 2008. It is surely not a coincidence that this was at the height of the financial crisis, when trust in the existing global financial architecture was very low. The thinking behind Bitcoin is nicely encapsulated in the quote above, from Satoshi Nakamoto, the enigmatic (and anonymous) founder of Bitcoin.

What is a digital currency? According to the Bank for International Settlements, digital currencies typically have three key aspects.

█ They have some monetary characteristics, such as being used as a means of payment, but are not typically issued in, or connected to, a sovereign currency. They are not the liability of any particular institution, nor are they backed by any central authority. Their value lies in their acceptance as a means of payment.

█ They are typically transferred through non!centralized distributed ledgers, which allow for secure P2P exchange in the absence of trust between parties.

█ They are almost exclusively developed and operated by non!bank institutions.

HERE TO STAY, ALBEIT STILL SMALL SCALE

Despite all of its very public ups and downs, Bitcoin has survived almost a decade without any successful security breach (the collapse of the Mt. Gox exchange in 2014 was due to problems with the exchange rather than with the currency itself), and is by far the most used and “valuable” digital currency today. That said, in scale it is still very much on the outer fringes of the global economy – Bitcoin has a market capitalization of just $10 bln. However, this is almost ten times greater than that of the next largest digital currency platform, Ethereum, which was in the headlines earlier this year over the DAO hacking scandal (which related to a flaw in code relating to an Ether!based smart contract, rather than the fundamentals of the currency itself).



Bitcoin market cap, $ bln

0

3

6

9

12

15

Jan

’13

Mar

’13

May

’13

Jul ’

13

Sep

’13

Nov

’13

Jan

’14

Mar

’14

May

’14

Jul ’

14

Sep

’14

Nov

’14

Jan

’15

Mar

’15

May

’15

Jul ’

15

Sep

’15

Nov

’15

Jan

’16

Mar

’16

May

’16

Jul ’

16

Sep

’16

Source: Blockchain.info

We are not going to delve into the technicalities of Bitcoin here, as this has been done extensively in many different sources. The point that we think is worth highlighting is that digital currencies exist, and Bitcoin is increasingly surviving the test of time. It (and other digital currencies) is not going to be un!invented, and logically the more merchants that start accepting Bitcoin, the more legitimacy it, or any other digital currency, will attain.

Hence, it makes sense for financial regulators to actually look at how these currencies can be regulated – although of course this is hugely ironic given that the whole ideology underpinning Bitcoin is that it does not require a central issuer, or, hence, a regulator, and that it is a fully distributed, self!regulating system. It is also a major challenge for regulators given the borderless nature of these currencies. But there is some progress – regulators in countries such as the US, UK, Canada and Australia, are all taking a relatively positive regulatory stance to Bitcoin.

Bitcoin has adequately resolved the issue of “double spend” without the need for a centralized issuer through Bitcoin nodes verifying each transaction added to the blockchain to ensure that the inputs for the transaction had not previously been spent. A strength of Bitcoin is that it is easy to securely transfer currency from one person to another, so it suits online commerce well. But one of the main drawbacks is that it is not so easy or cheap to convert bitcoin into fiat currency, largely due to regulatory constraints.

Bitcoin also carries a high degree of privacy, or pseudonymity. This means that bitcoin holders have their own cryptographically secure private keys which, together with a public verification key, are used to generate a digital signature authorizing a bitcoin transaction, so transactions are anonymous at a private individual level but viewable to all on the overall public ledger. In the eyes of some, especially regulators, this is a major red flag as it means bitcoins can potentially be used for illegal activities (such as we saw in the Silk Road scandal in 2013).

The other interesting characteristic of bitcoin is that there is a fixed supply (there can only ever be 21 mln bitcoins generated, after which point bitcoin miners will not receive rewards in the form of new bitcoins for verifying, or mining, transactions). So this tempers concerns about currency debasement, although the number of decimal places to which the currency can be measured can be increased (it is currently eight).

OVER TO YOU, CENTRAL BANKS

An interesting offshoot of the whole debate around digital currencies is that some of the more progressive central banks around the world are even looking at developing their own digital currencies.

In some senses, central banks already issue digital currency given that reserve balances that banks hold with them only exist in digital form. The broader question, however, is whether central banks could issue digital currency not just to banks, but also to individuals, although this would obviously have profound implications for the entire financial system. However, this is an area already being looked at by the Bank of England and Bank of Canada, and will no doubt become a topic of increasing interest in



the years to come, particularly as questions about the fallibility of the existing global financial infrastructure grow louder.

What fintech means for traditional branch banking

The development of many of the digital segments of retail banking that we have looked at in this report will have profound implications for the traditional bricks!and!mortar model of banking that is still so prevalent.

Data on global bank branch numbers are sketchy, with significant gaps in the World Bank’s numbers. However, it seems that in many countries bank branch numbers have been increasing over the past decade, particularly in developing economies such as India and Indonesia. In the US, data from the FDIC shows that the number of bank branches stopped growing in 2008, having increased by 20,000 to 83,000 since 1998. Since then, over the past eight years, only a net 1,000 branches have closed.

What can we learn from early technology adopters about the impact the shift to digital technology has had on branch networks, headcount and cost ratios? Scandinavia is well known for being among the global leaders in terms of banks’ shifting distribution and transactions to digital channels. We have had a look at the impact this has had on several leading banks in the region. Over the last decade or so, the peak to trough cut in branch networks by several leading banks has been around 45!60%, with headcount reduced by up to 30%. The positive impact on costs/average assets (which we think is a more useful indicator than cost/income in this case) has typically been 25!30%. With pressures on bank business models rising in a world of ultra!low interest rates and high regulation, it is surely only a matter of time before more banks globally start following the example of these Scandinavian banks and start massively reducing branch networks, and inevitably, cutting headcount as well.

Selected Nordic banks, decline in branch, headcount and costs/avg assets

!80%

!60%

!40%

!20%

0%

Headcount Branches Costs/avg assets

Danske Swedbank SEB Nordea Note: Data shows consolidated peak!to!trough decline over 2007!15.

Source: Companies

But will there still be a role for the bank branch in the future and if so what will it be? One obvious answer is that those branches that remain in place will be very largely focused on offering value!added advice and consultation on more complex financial products, with those customers wanting to use branches for transaction based services likely charged heavily for the pleasure. Spain’s BBVA, for example, has rolled out new branches that include pods in which customers and advisors can sit and share a computer screen to look at the same information, as well as upgraded digital banking facilities and ATMs. Thinking beyond this, branch spaces could also be used as hubs for digital app developers that are plugging into banks’ online services.



Brett King, Founder and CEO, Moven

Moven was founded in the US in 2010, subsequently launching a banking app based on a more behavioral and contextual approach to everyday banking and focused on mobile. Sberbank was an early stage investor in the company. Moven is now partnered with a number of fintech players and global banks.

We spoke to Moven’s CEO, Brett King. Aside from running the company, King is a renowned commentator and speaker on the future of banking and how technology is changing business. He has written several bestselling books on disruptive technologies in banking and beyond, and also runs the world’s first dedicated radio show on technology’s impact on banking and financial services, titled “Breaking Banks,” which has an audience of 1 mln listeners.

Can you tell us how Moven’s cooperation with Sberbank started?

Sberbank’s SBT Venture Fund led Moven’s Series A funding round in 2011 and we have maintained strong links with Sberbank’s management ever since. For Moven, Sberbank represents both an investment opportunity and also a potential partner from an execution perspective. What is clear from speaking to Sberbank’s senior managers is that “they get it.” Typically, senior management teams in big banks are skeptical about the potential for digital banking and impending decline in branch networks, but Sberbank takes this as a given that it will happen and plans its strategy around it. Compared to the big US banks, Sberbank is philosophically much more in tune with the way Moven is thinking.

Where does a player like Moven fit into the new financial landscape?

On a longer!term basis, we are seeing a shift away from product to experiences in banking. We are shifting away from debit cards, credit cards and personal loans to managing your money in a smart bank account and to accessing credit in a store when you need it. As a result, the universal banking model is starting to break apart, especially for millennials and Generation Z who don’t see the practicality of having a single banking relationship. This is where we come in. Partners like TD Bank [Canada] have trusted us to build an app for the day!to!day banking experience, and typically it is used much more than other parts of the online banking platform.

Moven was one of the first so!called “neo banks.” How difficult do you think it is for neo banks to build scale and monetize themselves rather than partnering or selling out?

It’s true that if Moven had a very large direct!to!consumer business, we may well not be partnering. And not a lot of fintechs have broken through with big scale. What Moven is trying to do is redefine what banking is and to disrupt. We are going to start to see some of the neo banks struggle. Moven has been at it for six years, it started in 2010, launched its first app in 2012, and a lot of the neo banks out there offer very little in terms of design and functionality that is different to what ourselves or Simple [sold to BBVA in 2014] have been doing for a while. I don’t think you can really get scale in the millions of customers unless you are offering something really different, like a Venmo or Alipay. You have to have a very different design premise and experience. Ant Financial built its mobile money market fund on top of its Alipay service, M!Shwari built on top of M!Pesa with 10 second onboarding on a smartphone. So the opportunities for scale are there.

Moven is not trying to be a bank in a conventional sense – it led with the concept that a bank account should be smart enough to show whether you are financially healthy (i.e. you sign in and see what you have spent, your typical spending, etc.). So we are not trying to take a bank account and put it on a mobile; rather we are redesigning a bank account for daily use to help people make more effective use of money in a low friction, seamless way.



In order to be disruptive and gain scale, the next generation of neo banks has to rethink financial experiences in a fundamental way. With interest rates and interchange where they are, it is not enough just to take monthly fees; neo banks will have to do credit, and that takes a different competency and a different level of funding. Structurally speaking, you are going to have to have credit if you want to make your direct!to!consumer model profitable.

Do you think P2P lenders are here to stay, particularly given that they have not been through a full credit cycle?

There is enough P2P [peer!to!peer] happening in enough markets that you can’t just discount it as a flash in the pan, it is going to be part of the mix going forward. But the thing P2P does is it changes the margins in the business and it makes conventional lenders look bad in terms of their cost of acquisition and in making their margins look heavy. At some point in time, if you look at neo banks and P2P, they start to devalue the performance of traditional FIs. Big global banks’ growth has flattened out, the branch model is not as successful any longer. Once we understand that neo banks can acquire customers consistently at a massive discount to traditional FIs, there will be a time when the market takes notice at how inefficient they are at acquiring. It is the same for P2P: old credit risk systems are actually more risky than a behavioral risk approach, and they offer lower borrowing costs. P2P is just a much more efficient model than the incumbents.

Looking 10 years out, the biggest FIs are going to be either those incumbents that have transitioned to become technology led, or they will be fintechs. Ultimately, the market will look for performers who are using technology well, such as behavioral credit risk. If incumbents haven’t made that shift already, then it is already too late. I can’t see the likes of HSBC and Deutsche Bank surviving in their current form as global banks, given they are just not putting digital first.

How do you see the payments space evolving and what will be the role of banks in it?

The payment interface in the past was cash, checks and then plastic. We are seeing the disruption of the physical artefacts of payments as a result of digital. The systems and networks that are emerging for payments aren’t

owned by banks, they are owned by Apple, PayPal, Alipay, etc. I don’t think there is a role for banks in payments. The way we design the likes of payment cards nowadays is going to be of zero impact in the future. Utility around the payment could be advice, or location!based offers.

We need to start redesigning capabilities for real!time commerce, and credit and debit cards will disappear. The new skills needed around payments are from companies like Apple, Google, Alipay etc, not the banks. It’s about the data and building seamless payment experiences. Banks will get relegated to being part of the piping and the ability for banks to make margins on payments is gone. So banks need to ask: what is the value of providing payments? In the old days, it was if you have a debit card, I can cross sell you a credit card or a mortgage. But if a credit card doesn’t exist because it’s now contextualized credit, then that advantage is gone.

What do you see for the role of biometrics in banking?

There is an acceptance or realization that what we thought of as KYC in the past is no longer secure, and is not a very good way to identify a customer, i.e. social security number in the US, it is pretty easy to get that information and it will never be secure again. If you can’t be sure that a person is who they say they are, then what can you do? We need to use a baseline of biometric data (e.g. face recognition, voice recognition, fingerprints) for KYC combined with “old” data, as well as social media presence, IP address and its geolocation, combined with behavior we see. Taken all together, this would show a combined set of data that is very strong.

The bottom line is that current KYC is very unsafe as it stands. Think about border control. Biometric passports at borders are very common now. This is because the technology is way better than humans – the software is 50 times more advanced than a human looking at your face and passport photo. Software just outperforms humans every time. For a bank, the single riskiest activity it does today is open a bank account using F2F recognition by a teller.

Apple, Facebook and Amazon have the potential to morph into key trusted identity brokers. Their cloud infrastructure in terms of security is magnitudes safer than that for banks out there. They are constantly being tested and probed, and in tests in which we have been



involved the likes of AWS can typically trump bank security systems.. AWS is constantly being hammered on multiple fronts and they invest way more in security than banks.

How do you see the potential for blockchain?

The way the financial ecosystem works currently is not flexible enough for the things people want to do. For example, think about things several years out like an autonomous car with its own bank account, or AI!based agents doing things on our behalf, or smart contracts.

We need to think about developing a different infrastructure around how we think about bank accounts, money movement and ID. SWIFT, MasterCard and Visa, etc., will have a very difficult time transitioning to a new environment and blockchain will potentially play a key role in future financial infrastructure.

Where blockchain is very positive is that it is a self!reinforcing system, a distributed database. You can’t hack one node to get access to someone’s money such as in the current banking system. SWIFT is also vulnerable, as we have seen recently. In a blockchain solution, the rest of network will see this. For sure, blockchain will be a part of the solution going forward.



Russia’s Financial Development

In this chapter we attempt to put Russia’s financial development in context and look at how it compares to other countries.

Russia’s economic development – far from US, better than BRICS peers

To compare the overall level of economic development in different countries, we use the most popular metric – GDP per capita weighted by purchasing power parity (PPP). According to the IMF, as of 2015, Russia had a per capita level of economic activity comparable to that of CEE neighbors such as Hungary and Poland, as well as to Greece and Portugal. Russia’s PPP!weighted GDP per capita of $26,000 is less than half that of the US, while on the other hand, it is more than double the average of BRICS peers. The recent trend, however, has not been particularly encouraging, as Russia’s PPP!weighted GDP has been falling since 2013 and unsurprisingly dropped 3% in 2015.

GDP per capita, PPP!weighted, $

0

10,000

20,000

30,000

40,000

50,000

60,000

US

Net

herla

nds

Swed

enA

ustr

iaG

erm

any

Den

mar

kC

anad

aU

KFr

ance

Japa

nSo

uth

Kor

eaIta

lySp

ain

Czec

h Re

publ

icPo

rtug

alPo

land

Gre

ece

Hun

gary

Rus

sia

Turk

eyBr

azil

Chin

aSo

uth

Afr

ica

Indi

a

Source: IMF

Russian GDP per capita, PPP!weighted, $

!15%

!10%

!5%

0%

5%

10%

15%

0

5,000

10,000

15,000

20,000

25,000

30,0002

000

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

201

0

201

1

201

2

201

3

201

4

201

5

Russian GDP y!o!y

Source: IMF

Russia is closing the gap but remains an underbanked country

Russia is relatively young in terms of the development of its retail banking services. Ten years ago, the share of the banked population in Russia stood at only 26%, according to Euromonitor data. However, the past decade has seen the share of the population with access to banking services grow to 75% as of 2015. However, on this metric, Russia still remains somewhat behind its peers, with developed countries at over 90%. EMEA countries such as Turkey, South Africa and Poland are still ahead, at around 80%, but the gap has been closing fast in recent years.

This suggests that there is further scope for financial service providers to reach the people currently outside the banking system in Russia. This may be an area in which fintechs could prosper. Mobile money has of course been a big driver of bringing unbanked people into financial systems in many countries, led by the example of M!Pesa in Kenya. Russia’s largest bank, Sberbank, has been running a mobile P2P payments platform for several years, and now has almost 20 mln users.



Share of banked population by country

0%

20%

40%

60%

80%

100%

Aus

tria

Spai

nJa

pan

Swed

enSo

uth

Kor

eaN

ethe

rland

sD

enm

ark

Port

ugal

Ger

man

yFr

ance

Can

ada

US

Czec

h Re

publ

icH

unga

ry UK

Indi

aIta

lyG

reec

eTu

rkey

Sout

h A

fric

aPo

land

Rus

sia

Chin

aBr

azil

Source: Euromonitor

Share of banked population in Russia

18%22%

26%32%

38%43%

48%55%

59% 63% 66%69%

75%

0%

20%

40%

60%

80%

200

3

200

4

200

5

200

6

200

7

200

8

200

9

201

0

201

1

201

2

201

3

201

4

201

5

Source: Euromonitor

Household debt relatively low after deleveraging

Over the past couple of years, Russia has been going through its first serious consumer credit crisis, and the decline in consumer loan books only seems to have halted recently. Following a period of deleveraging (consumer loans contracted by 18% from late 2014 to mid!2016), consumer loans (excluding mortgages) now stand at just 8% of GDP, which is well below the level of Russian peers Brazil (16%), Poland (14%), Turkey (13%) and Hungary (11%). By contrast, mortgages in Russia have seen phenomenal growth over the past several years, and banks’ mortgage books continued to grow even through the consumer lending turmoil of 2014!15. Having started off from a very low base, mortgages in Russia now stand at 5% of GDP, which is still one of the lowest levels in our country data set. Altogether, Russia’ household debt to GDP ratio is 13%, while the average debt burden per household is still low, even after ruble depreciation, at $3,000.

Total household debt/GDP

0%

30%

60%

90%

120%

150%

Den

mar

kN

ethe

rland

sC

anad

aU

KSw

eden U

SPo

rtug

alSp

ain

Japa

nSo

uth

Kor

eaG

reec

eFr

ance

Ger

man

yA

ustr

iaIt

aly

Chin

aSo

uth

Afr

ica

Pola

ndCz

ech

Repu

blic

Braz

ilH

unga

ryTu

rkey

Russ

iaIn

dia

Mortgage loans/GDP Consumer loans/GDP

Source: Central banks, BIS, IMF, Euromonitor, Eurostat, Sberbank CIB Investment Research

Average household debt, $ ’000

0

30

60

90

120

150

Den

mar

kU

SN

ethe

rland

sCa

nada

Swed

en UK

Japa

nA

ustr

iaFr

ance

Ger

man

ySp

ain

Port

ugal

Gre

ece

Italy

Czec

h Re

publ

icPo

land

Chin

aSo

uth

Afr

ica

Braz

ilTu

rkey

Hun

gary

Rom

ania

Russ

iaIn

dia

Mortgage loans per household Consumer loans per household

Source: Central banks, BIS, IMF, Euromonitor, Eurostat, Sberbank CIB Investment Research

Mapping household debt/GDP versus GDP per capita in PPP terms reveals that for its GDP per capita level, Russia’s retail debt is still relatively low in contrast to the likes of South Africa and China.



Household debt/GDP vs GDP per capita

Austria

Brazil

Canada

China

Czech Republic

Denmark

France Germany

Greece

Hungary

India

Italy

Japan

Netherlands

Poland

Portugal

South Korea

Russia

South AfricaSpain

Sweden

Turkey

UK

US

0%

25%

50%

75%

100%

125%

0 10,000 20,000 30,000 40,000 50,000 60,000

Reta

il lo

ans

/ G

DP

GDP per capita, PPP!weighted, $

Source: Central banks, BIS, IMF, Eurostat, Euromonitor, Sberbank CIB Investment Research

Distribution of financial services

An important angle to look at with respect to the context for fintech in Russia is how the distribution of financial services is developing. What we see is that Russia has been and still is heavily dependent on brick!and!mortar retail banks, although this is starting to change.

RUSSIA’S BRANCH NETWORK IS LARGE, BUT SHRINKING

Russia has about 37,000 bank branches, which leaves it lagging only India, China and the US. If we look at the density of branches, Russia is on par with the US, having 33 branches per 100,000 adults. Within our selection of countries, Russia unsurprisingly screens as relatively branch!heavy, with only a few countries having a denser branch network, interestingly including several large European states where the biggest banks are under great pressure, such as Spain, Italy and France, as well as Japan. This suggests there is decent potential for scaling down the branch network in Russia, and this has been the trend in recent years, as the number of bank branches peaked in mid!2013 at around 46,000 and has declined by 20% since then. We note, however, that there may well be a mini!resurgence of branch banking in Russia over the next few years as VTB and Russian Post roll out Post Bank, with plans for a network of over 25,000 branches within the next decade.

We appreciate that data on branches should be treated with caution for the obvious reason that it comes in all shapes and sizes, and Post Bank, for example, plans many small!footprint branches. While banks may not have been actively reducing total branch numbers, they may well have been reducing the footprint (and headcount) of branch networks.



Number of bank branches

0

30,000

60,000

90,000

120,000

150,000

Indi

aC

hina U

SR

ussi

aJa

pan

Braz

ilSp

ain

Ital

yFr

ance UK

Turk

eyPo

land

Ger

man

ySo

uth

Kor

eaCa

nada

Port

ugal

Sout

h A

fric

aG

reec

eCz

ech

Rep

ublic

Net

herla

nds

Swed

enH

unga

ryD

enm

ark

Aus

tria

Source: IMF

Number of branches per 100,000 adults

0

20

40

60

80

Spai

nPo

rtug

alIt

aly

Fran

ceJa

pan

Rus

sia

US

Pola

ndG

reec

eU

KD

enm

ark

Czec

h R

epub

licCa

nada

Swed

enBr

azil

Turk

eySo

uth

Kor

eaH

unga

ryG

erm

any

Net

herla

nds

Aus

tria

Indi

aSo

uth

Afr

ica

Chi

na

Source: IMF

Bank branches in Russia

0

10,000

20,000

30,000

40,000

50,000

Dec

’07

Jun

’08

Dec

’08

Jun

’09

Dec

’09

Jun

’10

Dec

’10

Jun

’11

Dec

’11

Jun

’12

Dec

’12

Jun

’13

Dec

’13

Jun

’14

Dec

’14

Jun

’15

Dec

’15

Jun

’16

Source: CBR, Sberbank CIB Investment Research

RUSSIA’S ATM INFRASTRUCTURE IS WELL DEVELOPED

In terms of its ATM network, Russia is similarly among the leaders. It has the third largest ATM network in the world, with just over 200,000 machines, lagging China (about 870,000 units) and the US (about 430,000 units). The density of Russia’s ATM network is also high in an international context: with 173 units per 100,000 adults, Russia ranks fifth after South Korea, Canada, the US and Portugal, and it is well above the level of its EMEA peers (60!80 units in Hungary, Poland and Turkey).

Although the ATM network in Russia is past its growth phase, having reached its peak in 2013, it is unlikely to decline substantially in the near future given that banks are trying to move conventional clients away from using branches toward “remote” channels, and ATMs are a decent starting point. Only more widespread use of digital services and cashless payments could realistically drive the downsizing of Russia’s ATM network, and this will take some time.



Number of ATMs, ‘000

0

200

400

600

800

1,000

Chin

aU

SRu

ssia

Indi

aBr

azil

Japa

nSo

uth

Kor

eaG

erm

any

UK

Cana

daFr

ance

Ital

yTu

rkey

Spai

nSo

uth

Afr

ica

Pola

ndPo

rtug

alA

ustr

iaN

ethe

rland

sG

reec

eH

unga

ryCz

ech

Repu

blic

Swed

enD

enm

ark

Source: IMF

Number of ATMs per 100,000 adults

0

50

100

150

200

250

300

Sout

h K

orea

Cana

da US

Port

ugal

Russ

ia UK

Japa

nG

erm

any

Aus

tria

Spai

nBr

azil

Fran

ceIta

lyTu

rkey

Chin

aSo

uth

Afr

ica

Pola

ndG

reec

eH

unga

ryD

enm

ark

Czec

h Re

publ

icN

ethe

rland

sSw

eden

Indi

a

Source: IMF

ATMs in Russia

0

50,000

100,000

150,000

200,000

250,000

Mar

’08

Sep

’08

Mar

’09

Sep

’09

Mar

’10

Sep

’10

Mar

’11

Sep

’11

Mar

’12

Sep

’12

Mar

’13

Sep

’13

Mar

’14

Sep

’14

Mar

’15

Sep

’15

Mar

’16


RUSSIANS STILL PREFER CASH

Despite the active growth of debit and credit cards, online banking, and mobile and other electronic payments, cash remains overwhelmingly the main payment vehicle in Russia. According to the CBR, in 2015 more than 75% of card transactions in Russia were ATM cash withdrawals, the rest being payments. Despite the evident trend of increasing card usage for payments – the share of card payments in total card transactions has increased from 9% in 2010 to 28% currently – Russia still lags most of its peers.

Structure of card transactions by country

96%

91%

89%

88%

83%

79%

76%

75%

70%

59%

53%

53%

52%

50%

50%

49%

44%

41%

38%

36%

35%

29%

14%

14%

0%

20%

40%

60%

80%

100%

Cana

daSo

uth

Kor

ea US

Chin

aSw

eden

Den

mar

kFr

ance UK

Net

herla

nds

Port

ugal

Spai

nTu

rkey

Japa

nBr

azil

Ital

yA

ustr

iaG

erm

any

Sout

h A

fric

aPo

land

Czec

h Re

publ

icH

unga

ryRu

ssia

Indi

aG

reec

e

Card payment transactions ATM transactions Note: Data as of 2015.

Source: Euromonitor

Share of card payments in total card operations in Russia

7% 8%9%

13%15%

18%

21%

24%

28%

0%

5%

10%

15%

20%

25%

30%

2008 2009 2010 2011 2012 2013 2014 2015 1H16 Note: Includes ATM cash withdrawals.

Source: CBR



CARD USAGE IS GROWING

Plastic cards are very popular in Russia, their number having reached almost 250 mln during 2Q16, according to CBR data, implying more than two for every adult. Debit cards started to gain traction at the beginning of the last decade and still make up almost 90% of all plastic cards in Russia, while credit cards only really took off about five years ago. There are now about 30 mln issued credit cards in Russia (we do not have data on actively used cards). This number was reached in 2014 and has not grown since due to the consumer credit squeeze.

Comparing Russia with other countries reveals that it has reached the same level of plastic card penetration as some European countries, but it still has a way to go to catch up with North American and Asian countries. Interestingly, China recently surpassed the US with a whopping 12 cards per capita (although in China’s case these are primarily pre!paid cards). As for credit cards, they are most popular in Canada, with almost three cards per person, while credit card penetration is still pretty low in Russia, at just 0.2 cards per capita, suggesting there is strong growth potential in this segment.

Active credit and debit cards outstanding, mln

!60%

!40%

!20%

0%

20%

40%

60%

0

50

100

150

200

250

300

4Q07

2Q08

4Q08

2Q09

4Q09

2Q10

4Q10

2Q11

4Q11

2Q12

4Q12

2Q13

4Q13

2Q14

4Q14

2Q15

4Q15

2Q16

Debit cards Credit cardsDebit cards, y!o!y Credit cards, y!o!y


Active credit cards outstanding, mln

0

5

10

15

20

25

30

35

4Q

07

2Q

08

4Q

08

2Q

09

4Q

09

2Q

10

4Q

10

2Q

11

4Q

11

2Q

12

4Q

12

2Q

13

4Q

13

2Q

14

4Q

14

2Q

15

4Q

15

2Q

16

Source: CBR

Financial cards per capita

0

2

4

6

8

10

12

Chin

aU

SJa

pan

Sout

h K

orea

Can

ada

Braz

ilU

KN

ethe

rland

sSw

eden

Port

ugal

Turk

eyFr

ance

Den

mar

kA

ustr

iaG

erm

any

Sout

h A

fric

aRu

ssia

Spai

nIt

aly

Czec

h Re

publ

icPo

land

Gre

ece

Hun

gary

Indi

a

Credit cards per person Other cards per person Note: Data as of 2015.

Source: Euromonitor

Credit cards per capita

0.0

0.5

1.0

1.5

2.0

2.5

3.0

Cana

daJa

pan

US

Sout

h K

orea

Swed

en UK

Braz

ilTu

rkey

Port

ugal

Chin

aSp

ain

Net

herla

nds

Den

mar

kFr

ance

Gre

ece

Russ

iaCz

ech

Repu

blic

Aus

tria

Ital

ySo

uth

Afr

ica

Pola

ndH

unga

ryG

erm

any

Indi

a


Source: Euromonitor



Share of credit cards in total cards

0%

10%

20%

30%

40%

50%

Can

ada

Swed

enTu

rkey

Sout

h K

orea

Japa

nU

KG

reec

eSp

ain

US

Braz

ilPo

rtug

alCz

ech

Repu

blic

Hun

gary

Pola

ndD

enm

ark

Russ

iaIta

lyFr

ance

Sout

h A

fric

aN

ethe

rland

sA

ustr

iaCh

ina

Ger

man

yIn

dia


Source: Euromonitor

RAPID GROWTH IN PAYMENT CARD INFRASTRUCTURE

The point of sale (POS) terminals network has seen phenomenal growth in Russia recently. Over the course of the last five years, POS terminals have grown three!fold, to 1.5 mln currently. Still there is clearly more room to grow, as at 13 POS units per 1,000 adults, Russia lags most European countries, not to mention South Korea, which incredibly has 150 terminals per 1,000 adults.

POS card payment terminals per 1,000 adults

0

40

80

120

160

Sout

h K

orea

Turk

ey UK

Spai

nD

enm

ark

US

Italy

Gre

ece

Port

ugal

Braz

ilSw

eden

Can

ada

Fran

ceN

ethe

rland

sCh

ina

Aus

tria

Czec

h Re

publ

icSo

uth

Afr

ica

Russ

iaPo

land

Hun

gary

Ger

man

yJa

pan

Indi

a

Source: Euromonitor

POS network in Russia, mln units

0.0

0.3

0.6

0.9

1.2

1.5

1.8

Dec

’07

Jun

’08

Dec

’08

Jun

’09

Dec

’09

Jun

’10

Dec

’10

Jun

’11

Dec

’11

Jun

’12

Dec

’12

Jun

’13

Dec

’13

Jun

’14

Dec

’14

Jun

’15

Dec

’15

Jun

’16

Source: CBR

INTERNET PENETRATION IS QUITE HIGH IN RUSSIA AND SMARTPHONE USAGE IS GROWING

As the internet and mobile phones have become important channels for delivering financial services, it makes sense to look at their penetration in Russia.

Internet penetration in Russia has come a long way over the past 15 years, having grown from just 2% of individuals using it in 2000 to over 70% in 2015. Its growth, however, has slowed since 2013, and while there is still some room to grow, Russia is already screening well relative to regional and emerging market peers.



Percentage of individuals using the Internet

0%10%20%30%40%50%60%70%80%90%

100%

Den

mar

kJa

pan

Net

herla

nds

UK

Swed

enSo

uth

Kor

eaCa

nada

Ger

man

yFr

ance

Aus

tria

Czec

h R

epub

licSp

ain

US

Rus

sia

Hun

gary

Port

ugal

Pola

ndG

reec

eIt

aly

Braz

ilTu

rkey

Sout

h A

fric

aC

hina

Indi

a

Source: ITU

Internet penetration in Russia

0%

20%

40%

60%

80%

200

0

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

201

0

201

1

201

2

201

3

201

4

201

5

Source: ITU

Mobile penetration has been growing fast in Russia over the last five years. The share of mobile users has increased from just over 30% in 2010 to more than 70% currently. The share of high!speed internet (3G/4G) users has also increased strongly, from below 10% to more than 40%. While Russia is not far from peers in terms of total mobile internet penetration, it has room to grow its high!speed internet usage, which is currently on par with the likes of Turkey and South Africa, but low relative to developed markets’ 70!80% range. We believe the growing number of smartphone users (already 50% of total mobile subscribers) could be what drives that growth.

Mobile internet penetration

0%

20%

40%

60%

80%

100%

Japa

nBr

azil

Sout

h K

orea U

SSw

eden

Can

ada

Aus

tria

Net

herla

nds

UK

Den

mar

kPo

rtug

alFr

ance

Spai

nCh

ina

Cze

ch R

epub

licPo

land

Italy

Ger

man

yG

reec

eH

unga

rySo

uth

Afr

ica

Russ

iaTu

rkey

Indi

a

Mobile internet users 3G/4G users

Source: GSMA Intelligence

Mobile internet and smartphone users in Russia as % of total subscribers

0%

20%

40%

60%

80%

1Q

10

3Q

10

1Q

11

3Q

11

1Q

12

3Q

12

1Q

13

3Q

13

1Q

14

3Q

14

1Q

15

3Q

15

1Q

16

3Q

16

Mobile internet users 3G/4G users Smartphone users Source: GSMA Intelligence

E!COMMERCE MARKET TRENDS SEEM CLOSELY TIED TO DIGITAL PENETRATION

Reliable sources for e!commerce market data in Russia are few and far between, so we take all the data with a pinch of salt. That said, according to eMarketer, Russia was one of the world’s top ten e!commerce markets in 2014, with $17.5 bln in sales. However, according to Data Insight, the share of e!commerce in the Russian retail market is still very low, at just over 2%. However, it seems poised to grow as people become more comfortable with new digital channels and cashless means of payment.



E!commerce market

10.1%

6.5%

13.0%

4.9%

7.3%

4.6%

9.0%

5.2%

2.2%3.8%

0%

3%

6%

9%

12%

15%

0

100

200

300

400

500

Chin

a

US

UK

Japa

n

Ger

man

y

Fran

ce

Sout

h K

orea

Can

ada

Russ

ia

Braz

ilE!commerce market, $ bln % of total retail sales (rhs)

Source: eMarketer

Russian e!commerce market, R bln

180 235 315 415

560 648

40

85

158

1.1%1.2%

1.5%

1.8%

2.1%2.4%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

0

200

400

600

800

1,000

2010 2011 2012 2013 2014 2015

Local Cross!border Local e!commerce as % of retail (rhs) Source: Data Insight



Oleg Tinkov, Founder and BoD Chairman, Tinkoff

Tinkoff (formerly TCS) was founded by Oleg Tinkov in 2006, and is the only pure online bank in Russia. It is now the number two credit card issuer in the country, behind Sberbank. Prior to setting up Tinkoff, Tinkov owned and operated a number of successful consumer businesses in Russia, including Tinkoff Beer, Tinkoff Restaurants and Daria. As the founding shareholder, BoD Chairman and one of the best known entrepreneurs in Russia, Tinkov plays a key role in driving his company’s strategy and fostering its culture of innovation.

We caught up with him to discuss his plans for Tinkoff and views on the future of banking.

Tinkoff is close to a decade old now. What is your vision for its future?

For us, the next step is to develop a financial supermarket, offering either our own products, white label or partner financial services. There have been attempts to do this before by others, but I think they were a bit too early. The next three to five years is now the right time. Consumers want to receive all kinds of financial services in one place, like a shopping mall. I believe we can build Tinkoff.ru into a financial intersection: we know how to bring traffic, we know how to convert it into clients. We are still learning, small and young, but we are well ahead of other players in Russia at least. Now we have about 8!9 mln unique visitors each month, when we are in the top 20 banks – which will happen – and have for example 30 mln unique visitors, people will know they can come to our site and get any type of financial service, there is no need to go elsewhere.

However, over the next five years we will still make more money on credit products than on commission products. But the outlook for the latter is very good. I believe we will make a lot of money in SME services, and, on the brokerage side, we are launching mortgages and insurance. My dream is to have 90% of revenues coming from non!credit sources, and for Tinkoff.ru to become a digital supermarket which can licence out its IT platform if it wants.

I don’t think about whether this model can work in other markets, Russia is a huge market, 140 mln people, but we could look at the UK, as continental Europe is over!regulated. But they would copy us before we enter that market.

I want to keep the company public. But we will no longer be a “bank” rather a supermarket, we will drop any bank name and be just “Tinkoff.ru,” and we will make money based on commissions. My aim is for us to be a $10 bln company, traded at 30 times P/E.

This is my dream, my goal. We are doing this little by little and our non!credit revenues are growing.

Do you see mobile as the key customer interface for Tinkoff in the future?

Of course! Sooner or later we will become mobile first, we are moving toward that end, and with smartphone penetration soon to approach 100%, I don’t see any more convenient, fast and geographically precise type of communication. Mobile banking will change the financial industry to a larger extent than digital banking did.

At the moment, over 60% of Tinkoff’s total staff are IT people, and the mobile development team is larger than the web one, which gives you an idea of where we are heading.

How do you think the way people make payments will change? Will there still be a role for plastic cards, upon which you founded the business?

In reality, it doesn’t really matter whether plastic cards survive or not. They will probably not exist in 10 years, but they are already being used less. For sure, everything will go onto your phone and we will be delivering “cards” not through our couriers but by air, uploading them onto our phone app and clients will immediately be able to pay or get cash anywhere using Apple Pay or Android!based NFC. So plastic will cease to be used, except for those people who would use it for backup. But cards will remain as virtual cards on your mobile device. So nothing is seriously changing for our business, except maybe that card printing and delivery costs will decline.



Who will be the winners in digital financial services?

The winners will be the companies that have access to data. It’s obviously Google, Facebook, Apple, messenger services, etc. Visa and MasterCard are also strongly placed given the infrastructure they have; Apple can’t really bypass them unless it buys them. Those companies that can stay closest to the consumer will win. In Russia, it could be Yandex or Mail.ru, as they have access to data. I believe the more data you have, the more you will be successful in financial services. If Google decides seriously to launch a credit or transactional business tomorrow, they ultimately could become the biggest bank in the world. They know far more about consumers than any bank. If they want to offer me services, they have all the information they need. Thank God that Google and Facebook are not really interested in seriously developing financial services!

Do you think branch!based banks will survive in the digital age?

At some point some I believe the largest banks will start to change. The banking system is very regulated, money is a serious issue, huge banks like JPMorgan Chase, Bank of America, Barclays, etc., will not just disappear, they will be transformed, they will develop digital services, will become like “Tinkoff Lite” banks. They have lots of capital, liquidity, regulatory and government support, they won’t just disappear and die. Mid!sized and small banks, particularly those with branch networks, may well be in trouble, but the huge systemic banks will change themselves. They will need to create new “lite” IT models in addition to existing platforms, such as the Tinkoff system. This is not very expensive for the big banks.

In the next decade or two, people won’t go to branches unless for very complicated investments and services. I believe 80!90% of branch networks will be shut down in the years to come. Most transactional banking has no need for branches.

But I do think the bank era is over, no one cares about banks. Banking will exist, but as Bill Gates said, “people don’t need banks.” This is true: people are tired of banks. People just need to satisfy their financial needs.

What do you think of the competition in Russia?

We have just two retail banking competitors in Russia: Sberbank and Alfa Bank. The rest are simply rubbish in my opinion. Sberbank is our biggest competitor; we really need to watch them. They have unlimited resources. They want to build a financial supermarket, and while they have challenges as a huge bank, eventually I am sure they will succeed. I trust in what they are doing; strangely enough, they are quite innovative given their size and they have a good team of people.

Apple Pay has just launched in Russia. How do you think it will do?

I think Apple Pay will trample over any payment competition based on its brand. It is simply the best brand on this planet, and the user experience with Apple products is unmatched. They will eat a huge piece of that cake.

Do you think Russia offers a supportive environment for fintech startups?

I don’t believe in fintech startups, I personally believe it is a bubble in many ways. Once I see the first fintech startup that succeeds in breaking even, or that is bought for a solid business reason (don’t tell me about Simple…), I may change my mind. So far, I see it as a trendy game, and an easy way to extract money out of investors’ deep pockets. In Russia, it doubly won’t work given that we don’t have early!stage investors or in fact any investment ecosystem.

What do you think about the prospects of the many digital bank startups we are seeing globally?

The only company that is really doing great things is Tinkoff! I can explain this. There are lots of new digital banking startups out there like Fidor, Atom, Simple, Monzo, etc. They are all very cool and funky, but none of them is profitable. And I know it is not very fashionable these days to be fintech and profitable, but for me this is rubbish – the business needs to be profitable. If the business is not (just look at Twitter), it



will struggle. We are and have always been profitable. Those new companies, they are for fintech conferences. They don’t get the customers in, and they are in transactional business, which is a 2% game, and 1% you pay to the payment networks. It needs to be a huge business if you charge 1%. QIWI used to do well when charging higher fees, but now it is much tougher as banks like us, Sberbank and Alfa Bank have very advanced and free payment services.

So then these new fintech players have to move into the credit business, but this is a huge leap, a totally different game. You need technology, data, people, IT, statistics. It is so easy to go into transactional business because there is no risk, there is no rocket science. The credit business is a huge risk and has huge potential gains. The only winners could be Google, Facebook, Apple, etc., as they have data and they know the customers. The bottom line is that without a credit business you cannot do much. These fintechs want to build nice apps, etc., and sell to big banks. They can do this, but it does not make for a sustainable standalone business. Tinkoff.ru is lucky enough to have 5 mln clients; we are on the threshold of large scale. Chinese fintech companies can do it, but it is not so easy in the West.

Given you think it is very hard to succeed in transactional banking rather than credit, why do you think Tinkoff can make a success of this shift?

Because we have got the scale, brand and a great team. New players simply don’t have any of those. Even for us it will be a tough and long fight.

What do you think about new technologies such as blockchain?

It is too early to be excited about technologies like blockchain, or digital currencies. There is lots of speculation now, people want to look smart and cool, but let the technology evolve and then we will see what we can do with it. But my team at Tinkoff is obviously actively looking at blockchain.

What advice would you give to a young Oleg Tinkov now looking to set up a financial services company?

My advice would be, do not think of building something just to sell to a bank. Think about how to build a standalone company that can survive by itself. Therefore, you need to think about data, about data analysis, credit business and volume business. Try to build a business that has its own standalone value, something innovative and sustainable. And then you will be able to sell for any price if you want. Too many fintech startups are built to sell to big banks; there are simply too many mobile applications out there.



Sberbank

Why is Sberbank in our fintech report?

Sberbank is Russia’s largest bank and a leader in the fintech space. In retail, the centerpiece of this is Sberbank Online (SBOL), which is by far the most used online banking platform in Russia, with over 33 mln active users. Sberbank is also the core shareholder of Yandex.Money, a leading non!bank online payments provider. But it is also applying new technology throughout the bank, and here we delve into what is going on digitally in areas such as corporate banking and insurance, as well as the blockchain. Another angle is collaboration with fintech companies both locally and globally to tap into innovation that can potentially add value to Sberbank’s business.

We caught up with the management in several areas to get a broad picture of Sberbank’s digital strategy in:

█ Retail banking.

█ Corporate banking.

█ Insurance.

█ Blockchain.

█ Venture capital.

Moving beyond banking

The creation of a financial ecosystem encompassing retail and corporate clients and B2B services seems to us to be the main thrust of Sberbank’s strategy in the coming years. In the retail space, this implies building out a marketplace based on a technology platform that allows for partner API plug!ins, and which offers a coherent customer experience irrespective of channel. This will over time likely incorporate lifestyle services in areas in which financial products are inherently involved, such as renovating, buying or renting a home, health issues, travel, matters relating to dealing with the government, education and charity. Sberbank will look to leverage its market!leading online platform to emerge as a key hub for customers’ increasingly “always online” lives and be able to offer them access through any channel at any time.

What this obviously means at the back end is the need for a highly robust and agile IT infrastructure, and this is what Sberbank has been moving toward over the past few years with the creation of a single core banking platform, unified front!end system and new data processing center. The thinking here is that the competition for customers will increasingly be shaped by who can best – and most quickly – understand customer behavior and respond by providing the most effective personalized and real!time services.

The same kind of thinking lies behind the digitalization of the corporate business, which plans to provide a key online hub for a huge range of useful services for SMEs. Another area that holds much potential is coming up with innovative ways for Sberbank to utilize the vast volumes of data it holds, and in the B2B space, this could touch upon areas such as IT services (Sberbank already effectively contains within it one of Russia’s largest IT “companies”), cloud computing and risk management/ratings services.



Retail banking – entering a new phase

Sberbank’s retail banking strategy over the past few years has led to a massive transformation in the way the bank serves its customers.

DISTRIBUTION – FROM BRANCH TO DIGITAL

On the distribution side, there has been a big effort over the past five years or so to work with Sberbank’s more than 80 mln active retail customers in terms of changing how they interact with the bank. One element of this has been reducing the amount of traffic through the branch network. Sberbank has looked to encourage the uptake of remote channels, led initially by ATMs and subsequently by digital channels, such as internet and mobile.

There has been a steady reduction in Sberbank’s branch network in Russia – it has declined by 22% to under 16,000 from its peak of over 20,000 in 2008. At the bank’s investor day last year, the management mentioned reducing the network to 13,000!15,000 in the coming years as the take!up of digital services accelerates. While not directly connected, this process may, if anything, be helped by the rollout of the Post Bank JV between Russian Post and VTB.

What is important here is that the process has gone hand in hand with efforts to help customers with the transition away from branch banking where possible. This has been achieved through a massive in!branch client education program. A network of 12,000 customer consultants has been deployed to teach customers how to use digital channels for many types of everyday transactions.

Meanwhile, Sberbank has invested heavily in building up its ATM network given that Russia remains a cash!dominated society (still over 70% of card usage is cash withdrawals, according to the CBR). Since 2009, Sberbank’s ATM network has expanded almost six!fold, peaking at over 90,000 in 2014. However, it seems to have passed an inflection point, which makes sense, as the use of non!cash payments has increased. An interesting point about the ATM network is that many ATMs have long included a wide range of services well beyond simple cash transactions, including a number of payment options and deposit management.

Sberbank’s branch and ATM network

70,000

80,000

90,000

100,000

10,000

15,000

20,000

25,000

2008 2009 2010 2011 2012 2013 2014 2015 9m16

Sberbank retail branches Sberbank ATMs (rhs) Source: Company

Hand in hand with the slowdown in the ATM rollout has been the build!out in recent years of Sberbank’s merchant acquiring business, as card transactions have started to eat away at the dominance of cash. Sberbank has been a major driver of promoting the in!store use of plastic cards in Russia, and its market share of POS card terminals has surged to about 60%.

THE RISE OF MOBILE

The other crucial strand in Sberbank’s retail banking evolution has of course been the massive investment in rolling out online banking services. Clearly you cannot have a quality digital front!end without a digital back!end, and Sberbank’s digital moves really started taking off about five years ago with the consolidation of Sberbank’s IT systems, including SBOL, onto a single IT platform



throughout Sberbank’s then 18 Russian regional units. This crucially laid the foundations for rolling out a unified online banking platform for customers.

Sberbank’s digital retail client base has grown strongly in recent years, to over 33 mln active users (those who have used the service in the last three months), which is equivalent to about 40% of Sberbank’s active retail customer base. The strongest growth is coming from mobile: mobile!app!only users were up from just over 1 mln at end 2014 to 10 mln at end 9m16, and there seems to have been a shift from web!only usage, which has declined this year. The shift toward mobile is likely to continue.

Meanwhile, Sberbank’s mobile!based P2P payments service has also grown strongly, to over 18 mln monthly users. Payments from one Sberbank client to another can be made in a matter of seconds, requiring only the recipient’s mobile phone number. To give itself greater control over the costs of mobile services, in October 2016 Sberbank announced that it is establishing a mobile virtual network operator based on Tele 2’s infrastructure.

Sberbank Online (mobile and web) active users, mln

8.015.8 18.8 16.40.9

2.2

5.8 7.5

0.5

1.4

4.610.0

0

10

20

30

40

2013 2014 2015 9m16

Web only Web and mobile app Mobile app only

9.4

19.4

33.929.2

Source: Company

A tangible result of the shifting focus in distribution has been the rapid rise of digital channels in retail banking transactions. Remote channels now make up over 90% of retail transactions. The contribution from remote transactions has been high for a while, so what is more interesting is the change in its breakdown. The share of ATMs has been steadily falling in recent years, while Sberbank Online’s share has grown nearly four!fold to almost one quarter.

On the lending side, the aim is to have at least 25% of consumer loans issued through digital channels over the next couple of years, and we are starting to see progress, as the share has increased by almost 4 pp in the past year.

Share of channels in retail transactions

14.5% 12.4% 10.5% 9.2%

63.0%58.1%

52.5% 48.4%

5.8%10.4%

16.9% 22.5%

8.2% 9.8% 10.4% 11.0%8.5% 9.3% 9.7% 8.9%

0%

20%

40%

60%

80%

100%

2013 2014 2015 1H16

Branch ATM Sberbank Online Text banking Direct debit

Source: Company

Share of consumer loans issued through digital channels

0.5%1.0% 1.1%

1.7%

3.3%

4.5%

0%

1%

2%

3%

4%

5%

1Q15 2Q15 3Q15 4Q15 1Q16 7m16

Source: Company



PRODUCTS – SURGING CREDIT CARD BUSINESS

On the product side, this distribution shift has been reflected in a few ways:

█ Rapid growth of Sberbank’s credit card business, which has gone from virtually zero market share in 2009 to over 40% in 1H16.

█ Credit card loans now comprise 12% of Sberbank’s retail loan book and over one quarter of its consumer lending.

█ On the revenue side, plastic cards now also account for about 30% of total fee income.

█ As for liabilities, the shift has been led by the roll!out of online deposits, with one in every four new retail deposits now opened online.

The online banking platform has been continually expanded to incorporate a wider range of services. Sberbank now offers several general insurance products through SBOL, as well as basic retail brokerage services and access to credit histories. On the non!financial side, this currently focuses primarily on payments for a range of non!financial services such as taxes, utilities, media, transport, charity and tickets. In October 2016 Sberbank became the first Russian bank to introduce Apple Pay payments, also incorporating it into its online banking platform.

Cybersecurity is emerging as a major issue for digital financial services, and Sberbank has been ahead of the game here. In 2015, for instance, it launched its breakthrough SBOL app for Android, which incorporated Kaspersky antivirus software to ensure that client data and actions are protected.

Sberbank credit card portfolio and share of retail loans

0%

4%

8%

12%

16%

0

200

400

600

800

2012 2013 2014 2015 6M16

Sberbank credit card portfolio, R bln Share of total retail loans (rhs)

Source: Company

Sberbank credit card market share in Russia

0%

10%

20%

30%

40%

50%

Dec ’10 Dec ’11 Dec ’12 Dec ’13 Dec ’14 Dec ’15 Sep ’16

Source: CBR

DESIGNING PRODUCTS AROUND CUSTOMER EXPERIENCES

The next stage of the retail banking evolution – although in reality this is the case now across the whole bank – involves taking the transformation of both the back end of the business and the customer!facing front end to another level.

At the back end, the IT infrastructure is being overhauled to create a single, unified open!source platform extensively using in!memory and cloud computing. The essence here is the aim to transform the bank’s speed and agility in product design, marketing and distribution so that Sberbank can make far more effective use of the rapidly increasing amount of real!time data it has available to it, and more effectively target customers with personalized and real!time services.

At the front end, the retail banking proposition is moving toward building out an online marketplace which will over time expand beyond purely financial services, moving into such lifestyle areas as home life (e.g. issues around renovating, buying or renting a home), travel (e.g. booking flights and hotels, travel reviews and topping up metro cards), health care (health!related information, lists of clinics etc.), interactions with the government (e.g. tax payments), charity and shopping (including promotions).



A key element of this modernization involves rethinking the whole architecture of product design to have it revolve around customer experiences. An example of this is mortgages, a market in which Sberbank has an over 50% share. A mortgage is just one element of people’s aspiration to own an apartment or house. Hence, Sberbank is looking at how it can facilitate as many parts of this process as painlessly as possible for the customer. This will include everything from a listings database to agent networks and financing, all in one app or section of SBOL.

The key point here is that Sberbank now has a massively popular online banking platform in SBOL which could become the focal point for deepening online relationships with retail customers, ultimately with the aim of cross!selling more business over the course of a lifetime relationship.

Sberbank’s digital marketplace

Individuals

Online merchantsSales and revenue growth

Sales conversion improvementAverage ticket growth

P2P marketplacesInstant and secure transfersUbiquity and convenience

Mobile ServicesInstant payment facility linkage

Lower transaction risk levelsSales and average ticket growth

Delivery servicesDecreasing cost of cash management

Companies

HoReCa

Instant e!invoicing using person’s mobile phone # or emailInstant payment confirmation

Integration with Sberbank Business Online

Convenient mobile paymentMerchants know and understand their

customer baseB2C communication platform,

coupons etc.

Instant and secure payment in desktop and mobile environmentMoving from ads to smart subscriptions

Single Smart Assistant for invoices, reminders, advice etc.Convenience and security are guaranteed by Sberbank

Source: Company

EXPANDING THE DIGITAL FOOTPRINT

We expect product development to keep coming thick and fast over the next couple of years. This may include extending SBOL’s integration with leading online merchant platforms, building out a messaging platform with a P2P payment function that can be integrated into major messaging platforms and rolling out more fully online retail lending products. The aim here is to think about expanding Sberbank’s digital footprint beyond its core mobile app, web interface and text service to better service existing customers and attract new customers through as wide a variety of digital channels as possible.

The marketplace concept also ties in with Sberbank’s increased collaboration with leading fintech companies across a wide range of areas, with the intention of both strengthening Sberbank’s proprietary offerings and allowing it to move toward a fully!fledged API!based marketplace model by end 2018. We look at this in a bit more detail later.



Corporate banking – digital transformation

We think there are two main interesting elements of Sberbank’s digital corporate banking strategy:

█ The development of the online banking platform, which is intended to offer a one!stop shop for a wide range of services throughout the life!cycle of a company.

█ The roll!out of Evotor smart terminals to small businesses.

ONLINE BANKING PLATFORM

The testing and development of the updated digital banking platform began in 2014, and the platform went live in late!2015, with plans for enrolling almost all of Sberbank’s 1.5 mln corporate clients by the end of 1H17. The main customer segment using the online platform in the early stages is Sberbank’s 1.2 mln small business and entrepreneur clients.

The idea behind the platform is to provide a comprehensive range of products and services for companies throughout their life!cycle, from opening and registering a business to marketing and trading, developing CRM and partnerships, managing payroll, accounting and taxation, and financing (of which more later). The thinking is that by providing an efficient and reliable online service, clients will keep coming back and incorporate the platform into their everyday business activities, increasing the opportunities for cross!selling more products and services.

Taking this further, by teaming up with various service providers to offer additional white!label services, such as accounting, business analytics and website creation, Sberbank is looking to turn the online banking platform into a one!stop marketplace for companies. Revenues would primarily be driven by transaction fees and revenue!sharing agreements with third parties.

Below we show a selection of some of the main services being offered.

Sberbank’s digital corporate banking ecosystem

STARTING A BUSINESS

• Business school for education • Registering a business and opening an account

from home • Support for any issues arising

SELLING/BUYING GOODS AND SERVICES

• Business card websites for online promotion of goods and services

• E-commerce to recruit partners and attract customers

• Transactions with customers: smart cash register, acquiring

• E-invoicing for electronic document turnover

between a legal entity and a bank • Online transactions with counterparties • Transactions with individuals • International economic activity and foreign

exchange control, conversion payments

WORKING WITН COUNTERPARTIES

INTERACTION WITH GOVERNMENT

• Reporting • Tax payment • Providing notice of legal address or taxation rules

changes • Access to government contracts and orders

RUNNING A BUSINESS

• Payroll program • Corporate card • Cash collection • Accounting • Management accounting • Warehouse management and CRM • Cash management to control the group of

companies’ funds and accounts in other banks

• Credits • Investments • Leasing • Factoring • Deposits • Insurance

GETTING/ALLOCATING FUNDS

Source: Company

There are several interesting elements of the online platform. These include a business analytics service which enables clients to upload financial statements and analyze sales and cash flow trends; accounting services (via a partnership with Russia’s largest accounting service 1S); guaranteed payment services, which serve as the equivalent of a letter of credit for small companies, with Sberbank acting as the intermediary between the buyer and seller of goods; and collateral insurance services.



WHERE DOES CREDIT FIT IN?

The online platform incorporates some elements of the application process for borrowing. Current regulation requires physical verification of clients during the KYC process. Individual entrepreneurs who are already customers on Sberbank’s retail platform can obtain credit online.

While Sberbank has over 50% market share in SME transactions, its share of the SME lending market is less than 20%, and shifting more of the credit process online will further decrease the time it takes to receive credit and should increase Sberbank’s share of the SME lending market.

One way the bank is using the online platform to change this is providing an easy!to!use online checklist including all the requirements for applying for a loan, so that customers can be sure they have the documentation they need when going to the branch. Another important change on the SME crediting front is the introduction of pre!approved loans for clients for which Sberbank already has a clear enough picture of cash flows; this type of credit can be provided within a couple of hours. These kinds of changes are already having a clear impact. The share of sales through digital channels has more than doubled in the past 18 months, to 14%, and the aim is to reach 20% by end 2016 and 40% by end 2018.

EVOTOR SMART TERMINALS

The other big digital corporate project is Evotor, a joint venture between Sberbank, ATOL (one of the biggest producers of retail cash registers) and Andrei Romanenko (one of the founders of QIWI).

Evotor is a company that has developed smart terminals that combine small cash registers (several times less expensive than standard ones) and simple sales analytics functions. The terminals are aimed at small companies, particularly in the retail space, and include everything from payments (they have a smart card reader) to CRM, cloud services, iBeacon connectivity, the ability to scan goods for sales and inventory management, accounting and automatic submission of tax reports. The smart terminals first went on sale in July 2016, with plans to roll out across all of Russia by the year end. A big driver of the early take!up has been the tax payment processing functionality.

The target market for these terminals in Russia is likely 1.5!2.0 mln companies, and by end 2018, Sberbank aims to have sold 0.5 mln units. Prices start from R20,500 ($325), so the terminals are quite affordable.

Whereas the online marketplace is targeted at business owners, accountants and the like, the smart terminals are intended for those actually working on the front lines of small businesses.

Evotor smart terminal

� Online payments

� Mobile cashbox

� Accounting

� Reporting

� Procurement

� CRM

� Loyalty program

� Online banking Source: Company

Insurance – rethinking the customer experience

The insurance space in Russia is a long way from fully embracing the possibilities offered by new technology. Today, online insurance amounts to less than 1% of the total insurance market in



Russia. Moreover, clients who might consider buying online have a quite different profile from typical offline clients. This all suggests that this segment has huge potential. Sberbank Insurance, led by CEO Hannes Chopra, has some interesting approaches in terms of its digital insurance strategy.

There are a few relevant areas here:

█ The regulatory backdrop and how it is changing.

█ Fintech startups beginning to emerge in the insurance space.

█ Sberbank Insurance’s plans to digitalize its insurance offering.

REGULATORY HURDLES REMAIN

On the regulatory front, several obstacles are holding back the development of online insurance. First, in order to protect consumers against potential fraud, current regulations cap the maximum price for selling financial products online without identification at R15,000. This restricts the ability to fully sell certain insurance products such as car or health insurance online. The CBR is looking into the matter, trying to balance the interests of merchants and consumers. Another obstacle to moving the insurance value chain online relates to the fact that when an insurer pays a claim, it is required to have the original physical documents. This means that instead of uploading a copy of the documents online, clients have to send it by mail or even come to the office in person.

Despite the slow progress from insurers, startups are appearing in the Russian insurance space, in particular companies offering analytics that allow for personalized offers to clients, while others are looking at how big data and blockchain technology can potentially be used in the relationship between, for example, an insurer, a client and a vehicle service center.

As for Sberbank itself, the general insurance team is aiming to rethink how insurance fits into customers’ lives. One of the underlying problems that it, and more broadly, the insurance industry faces is that the interaction between customers and insurers, particularly during the claims process, involves a lot of friction. From the customer’s perspective, claims are usually made because something unfortunate happened, while from the insurer’s perspective, a key aim is to find out if the customer is lying or the claim is fraudulent.

RETHINKING THE CUSTOMER EXPERIENCE

In this context, Sberbank Insurance is trying to approach things from a different angle, by integrating the provision of insurance into broader, more positive lifestyle!related issues. A new website will focus on this ecosystem model, enabling clients to access information on a range of lifestyle!related topics.

Sberbank Insurance is also working at applying technology to improve some core insurance products. One example is work on a Smart CASCO (comprehensive vehicle insurance) product, with the aim of providing a much more dynamic and mobile!based interface with customers, as well as incorporating in!car telematics to better understand and price individual risk. Sberbank Insurance also organizes its own fintech startup sessions.

Sberbank Insurance already offers full or partial online products for individuals, including insurance for travel, property, bank cards and mortgages, as well as multi!risk products. These products can also be bought through SBOL.

Building fintech partnerships locally and globally

Sberbank is in a very enviable position in terms of the fintech space in Russia. Given the strength of its market position across pretty much all financial segments, it is the company that everyone in this space wants to partner with. What we think is a good part of Sberbank’s approach here is that there



is generally a culture of realizing what can and cannot be done in house, with a massive focus on working with leading fintechs with a view to developing a platform that is versatile and allows for API plug!ins from partners offering innovative online services.

This is being done in a few ways. Locally, Sberbank is partnering up with companies across a wide spectrum of the fintech space, including the following areas:

█ Big data analytics – including visualization, scoring and machine learning.

█ Biometrics – voice and facial recognition, virtual reality.

█ Cyber security and identity management.

█ Payments.

On a more global level, Sberbank has been actively tapping into new fintech ideas through its venture capital fund launched in 2013. This is massively important to the future of the business in terms of learning from, and potentially partnering with, some of the most innovative companies in the fintech space globally. Investments through this fund include:

█ GridGain – a US!based data processing and analytics provider.

█ Mobeewave – dongle!free mobile payment solutions.

█ Moven – a mobile!centric banking app, a pioneer in the digital banking startup space.

█ Walkbase – an in!store real!time analytics provider.

█ Etoro – the world’s largest social investment network.

█ Sequent – digital wallet services.

█ Uber – the groundbreaking taxi service which started operating in Russia in 2013.

Blockchain in Sberbank

Sberbank operates a team dedicated to exploring distributed ledger technology (DLT), more commonly referred to as the blockchain. Sberbank is involved in DLT research at both local and international levels. Locally, it is a member of the working group set up by the Central Bank, along with several other Russian banks, which offers a valuable forum for testing out blockchain solutions within a managed!risk, sandbox!style format. Internationally, in September 2016 Sberbank signed up for the Hyperledger consortium, which is a Linux Foundation!led project that brings together over 80 banks and companies to develop blockchain technology. It has also signaled a desire to join the rival R3 consortium.

Among the many use cases of blockchain that are being looked at, we highlight a few particular areas of interest:

█ Document exchanges between banks, companies and certain federal agencies.

█ Settlement between banks within the Sberbank group’s international network, currently focusing on message rather than value exchange.

█ Document workflow, such as for mortgages, which can involve several parties, from banks to buyers, sellers and the federal agency that registers property rights.

█ Trade finance transactions involving different participants (such as banks, buyers, sellers and logistics companies) and legal domains.

█ Managing power of attorney documents between Sberbank, notaries and the relevant federal agencies. This could be particularly effective in reducing fraudulent notarization of assets.



█ Employment/education records, which could be visible to a number of different parties, from employers and educational establishments to government agencies. Again, this is an area in which there is a lot of fraud in Russia.

We spoke to the head of the DLT team in Sberbank, who outlined some of the main challenges for the adoption of blockchain solutions. First and foremost, this includes the capabilities and maturity of the platforms themselves (such as R3’s Ethereum!based platform and Linux Foundation’s open source Hyperledger), as well as having the space to experiment, although the latter seems to be well understood by the Central Bank. Then there are the critical issues surrounding the level of decentralization and “rule!making” within permissioned blockchains, and the extent of the involvement of certain centralized parties such as the Central Bank or federal agencies.

Putting this all together: Implications for Sberbank

The point of all this investment in technology transforming the back!end and front!end of Sberbank’s business is ultimately to strengthen its relationship with existing customers and to reach out to new customers, as efficiently as possible. The positive revenue and cost implications should mean a more profitable business, which would be good news for shareholders.

On the revenue side:

█ Increasing fee income through growth in transactional businesses such as card services (already about 30% of fee revenue), and mobile services, such as payments. On the corporate side, the roll out of a digital one!stop shop and supplemental services (i.e. Evotor terminals for SMEs) should increase fee income streams.

█ Management has been consistently upbeat on the prospects for delivering robust fee income growth (guiding 15%+ 2016!18 CAGR), and pushing for more non!credit related fee opportunities makes obvious sense given what may well be a low credit growth environment for a while to come. Importantly this should also reduce the cyclicality of the business, which investors should welcome.

█ The move towards stepping up online lending should over time support growth in important areas of the market such as retail and SME.

On the cost side:

█ The shift to digital has been apparent for a long while, and as this process continues on both the retail and SME side, this should enable further savings to be made in branch infrastructure. Earlier in this report we looked at the difference this had made to cost ratios for early adopters in Scandinavia, and the implications are clear.

█ Beyond this, moving to more digital, less paper based services should help cut costs, as should the diminishing share of cash transactions generally, with cash handling, moving and securing an expensive but low margin business.

█ Sberbank targets bringing its cost/income ratio down below 40% over the next few years, driven by the positive revenue and cost implications of its fintech investments. The share of IT spend in operating expenses is guided to rise to 10% by 2018, with staff costs down from 56% in 2015 to 52% in 2018.



Tinkoff

Why is Tinkoff in our fintech report?

Tinkoff (the two key parts of which are Tinkoff Bank and Tinkoff.ru, the online financial supermarket) is the original and, in our view, most successful fintech story in Russia. It has survived for almost a decade as an online bank, having decided to pursue a branchless strategy long before many banks globally had even considered starting to cut back their networks. Tinkoff has proved that branches are not needed to operate a sustainable and successful bank. TCS Group, the parent, has been profitable every year since 2009, its balance sheet having increased from R6 bln at end 2009 to over R150 bln currently, and Tinkoff is now the number two player in the Russian credit card market behind only Sberbank.

The culture of the bank is heavily influenced by the entrepreneurial exuberance of its founder, Oleg Tinkov, beyond which the company has a settled and strong management team and employs a small army of technologists. There is an emphasis on creativity and innovation, as exhibited by the continuous adaptation of the business.

From card monoliner to full!service (non!branch) banking

Before we look at where Tinkoff is going, it is worth looking back at where it came from to highlight how the business has evolved. Tinkoff began in 2007 as a monoline direct!mail!distributed credit card lender. Over the next couple of years, it shifted to an online!driven distribution platform underpinned by a network of couriers who hand!delivered cards to customers and obtained the necessary face!to!face approval. At the time of the global financial crisis of 2008!09, Tinkoff was a purely wholesale!funded business. The crisis made the company recognize that it needed to develop a more sticky and stable deposit funding base. After an attempt to collect deposits through post offices failed to gain traction, Tinkoff opted for online deposits. These proved a big success, helped by high deposit rates (which were possible given the lack of a branch infrastructure) and a market!leading online banking platform.

Credit card portfolio and market share

4.2%

5.8%

7.2% 7.5%6.7%

8.3%

9.6%

0%

2%

4%

6%

8%

10%

12%

0

20

40

60

80

100

120

2010 2011 2012 2013 2014 2015 1H16

Credit card portfolio, R bln Market share (rhs)

Source: Company

Number of credit and debit cards, mln

0.5

0.9

1.5

1.9 22.2

2.5

0.02 0.04 0.10.3 0.4

0.9

1.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

2010 2011 2012 2013 2014 2015 1H16

Credit cards (active) Debit cards (issued)

Source: Company



ENTER TINKOFF BLACK

The combination of Russia’s consumer finance downturn and the sanctions against Russia in 2014!15 necessitated further deposit expansion, and having made little headway in the payroll market, Tinkoff focused on building up its interest!paying debit card product, Tinkoff Black. The emphasis here has been on differentiation and offering an excellent product with a lot of popular features (e.g. a relatively high interest rate, free ATM withdrawals anywhere, cashback and loyalty programs, and an excellent online platform) to be used mainly as a secondary or even primary account. Customers can transfer funds from whichever bank they have their salaries wired to or even tell their employer to pay their salary into their Tinkoff account. The growth of Tinkoff Black over the past couple of years has been very impressive – from 0.4 mln cards issued as of end 2014 to almost 1.5 mln at end 1H16. Tinkoff is now the sixth largest MasterCard issuer in Russia. The current account forms a key part of the effort to cross!sell more transactional banking products through the Tinkoff.ru financial supermarket.

Tinkoff.ru financial supermarket

The core thinking behind Tinkoff.ru is pretty straightforward. As its business has grown and evolved, Tinkoff has moved from being a credit card monoliner to also offering products on the liabilities side (i.e. deposits and current accounts). It has faced a strategic choice of whether to focus more deeply on expanding in credit – perhaps into other areas of household lending, such as mortgages and cash loans – or building out the non!credit side of the business. The financial supermarket enables it to remain a key player in credit cards, which should be a decent structural growth story in Russia over the next several years. The management still expects credit cards to contribute around 70% of profits by 2019.

LEVERAGING ITS COMPETITIVE ADVANTAGES

The financial supermarket should also enable Tinkoff to leverage many of its strengths to grow fee income and reduce the cyclicality of its business. These strengths include:

█ A high!quality online platform. The first element is the online platform itself, which is highly regarded within the industry and attracts millions of visitors each month, providing a high!quality and convenient point of contact for existing and potential customers. Mobile banking is becoming increasingly important, and Tinkoff arguably has one of the best mobile offerings among Russian banks. So Tinkoff has the infrastructure in place to encourage existing and potential clients to access a broadening range of financial services. This is at the heart of the marketing funnel that is central to Tinkoff’s business.

█ An increasingly strong brand. A number of surveys place Tinkoff among the most recognized and popular Russian retail bank brands, typically behind the likes of only Sberbank, VTB 24 and Alfa Bank. Tinkoff is the leading TV advertiser among Russian banks at the moment, which has helped it attract an increasingly affluent customer base via Tinkoff Black and generate a lot of new business through word of mouth. While the strength of a brand is hard to measure, we think it is a factor in Tinkoff’s favor as it pursues the financial supermarket model.



Top 10 internet banks, percentage of surveyed online banking users

81.8%

9.1%

7.1%

6.2%

3.7%

3.4%

2.6%

2.5%

2.3%

2.0%

0% 20% 40% 60% 80% 100%

Sberbank

VTB 24

Alfa Bank

Tinkoff Bank

Russian Standard Bank

Home Credit & Finance Bank

Bank of Moscow

Otkritie Bank

Promsvyazbank

Raiffeisen Bank

Source: Markswebb Rank & Report

Most efficient mobile banking platforms, ranking

2

1

43

8 11

3

1

2

511 10

1

7 105

4

Sberbank Tinkoff Bank Alfa Bank Post Bank VTB 24 Bank of StPetersburg

iOS Android Windows Phone Source: Markswebb Rank & Report

█ The ability to produce popular products. To make sure the switch to the financial supermarket model is successful, Tinkoff will need to get its new products and services right. And while not always the case, it has certainly achieved success with the likes of the All!Airlines credit card and Tinkoff Black debit card.

█ An acquisition machine. The keys to making the transactional business work are scale and the ability to generate leads and convert them into acquisitions, which could turn the brokerage arm into a much stronger revenue vehicle. Tinkoff.ru undoubtedly has very potent lead generation capabilities. The site averages 8!9 mln unique visitors per month, and Tinkoff has been investing heavily in marketing. It is the leading TV advertiser in terms of gross rating points in Russia. It is also number three among Russian banks in terms of brand interest, according to Google. The ability to convert leads into sales is obviously critical. Tinkoff has 5 mln active customers, including 2.5 mln activated and used credit cards and 1.5 mln Tinkoff Black debit cards. It also has around 300,000 “light” customers who, having received a Tinkoff ID with as little as a name and phone number, can make a wide range of payments online, from mobile phone top!ups to utility bill and fine payments to games. Tinkoff aims to either turn these clients into full Tinkoff.ru customers or cross!sell them products from partners.

█ Leading in!house IT. Sitting behind the front end is an army of developers and engineers that builds the entire IT infrastructure in!house. We think Tinkoff is rightly seen as one of the most technologically sophisticated companies in Russia, employing around 400 developers. The main reasons for the focus on IT is that it provides the ability to scale and quickly implement new business processes (which is obviously crucial for an online business) and functionality. Having started out as a credit card monoliner, the effective use of data in underwriting has always been central to Tinkoff’s business, but as it diversifies its business and looks to become a financial hub for customers, clever data management is clearly critical in other areas as well. While credit data remains central to its underwriting, Tinkoff is making increasing use of behavioral data, including social media and locational data. The bank works hard to attract talented developers and operations employees – it runs a fintech course at Moscow’s leading technology school (MIPT) and regularly conducts “Olympiads” and “hackathons” to attract new talent. The push into new technologies also involves a web!based call center (half of the employees of which work at home) and AI projects including chatbots and voice recognition projects. While Tinkoff’s management recognizes how challenging it is to hold on to good IT staff when Russia’s largest bank is investing heavily in similar areas, the company has been able to do so by providing an environment in which developers can work in small, horizontal teams and see tangible results. We have spent quite a lot of time at Tinkoff’s offices in preparing this report, and it is clear that there is a vibrant culture of creativity and idea exchange, which we believe is hard to replicate.



But why has Tinkoff not simply remained focused on doing what it does very well – issuing credit? The commitment to credit cards certainly remains in place, and there seems to be little desire to move into a very different area like mortgages, where the state banks have a stranglehold, or into bigger!ticket cash loans, which entail higher risk. We think this thinking is to some extent capital!driven, given that these are capital!intensive businesses, and perhaps also due to the company recognizing that the strong growth period for household lending has passed. However, at the same time, the move to transactional banking makes sense for some of the reasons outlined above.

The main idea behind the financial supermarket concept is making the product a key and essential part of customers' financial lives. Tinkoff recognizes that there are some things it can do itself and others that it should broker, but as has been the case with Tinkoff as a whole over its 10!year history, this model will no doubt evolve over time. One thing we especially like about the company in addition to its willingness to innovate is its ability to admit that things have not worked out so well (such as e!wallets and post office deposits) and move on. We imagine this would be the case with the financial supermarket as well should it prove not as successful as planned.

Tinkoff.ru financial supermarket

FINANCIAL SUPERMARKET

TINKOFF.RU

Non!customers

� Product info�Marketing info� Landing pages

� Payment and transactional services� Subscriptions� Cross!selling

Do not require full KYC Require full KYC

� Complete set of banking services� Account opening� Sending “smart couriers”

Broker platform

Trav

el*

Cash

loan

s*

Carl

oans

*

Insu

ranc

e*

Reta

ilse

curi

ties

Mor

tgag

es

CU

RR

ENT

AC

CO

UN

TS

Cre

dit

card

s

Acq

uiri

ng

Insu

ranc

e

Mob

ilean

dpa

ymen

ts

SME

Proprietary products

“Light” customers “Heavy” customers

ACCESS TO ALL SERVICES WITH A SINGLE TINKOFF ID

* currently in development

Source: Company, Sberbank CIB Investment Research

KEY PARTS OF THE FINANCIAL SUPERMARKET

At the bank’s recent investor day, the management guided that non!credit earnings should account for around 30% of the group’s net income by 2019. So what could be some of the key drivers of this potential profit growth?

█ SME services. This business focuses on providing non!credit related services to SMEs through the Tinkoff.ru online platform. The services offered include online banking, current accounts, payroll projects, consulting, tax payments and accounting. There are no plans to offer credit to SMEs – this is a purely fee!based business. The SME segment is one for which the management has high hopes, believing that it is not well served by larger banks, which tend to offer slower service and are less accessible online. Tinkoff also hopes to generate new clients both by cross!selling to the small business owners among its retail customers attracting new clients thanks to the quality of



the online platform. The business has been up and running for a few months now and already has around 25,000 active accounts, with about 7,000 being added per month now. Tinkoff aims for 100,000 clients by end 2017 and 200,000 by end 2018, which would put its market share at around 5%. The management expects the business to break even in 2H17 and contribute around half of the R6!10 bln in projected net income from non!credit business lines by 2019. While the early indications have been promising, this is a new segment for Tinkoff. Moreover, Alfa Bank is generally thought to have a solid SME offering, and Sberbank now seems to be getting its act together, so there is competition.

█ Mortgage broking. Tinkoff.ru is trying to reinvent the way mortgages are obtained in Russia, turning it into a much quicker (cutting the average time in half, to less than two months) and largely online process. Launched last year, the online mortgage broking program involves eight partner banks including leading private mortgage players Deltacredit, Absolut Bank and UralSib Bank and generates 20,000!25,000 applications per month. Although Tinkoff does not currently work with any of the big five state banks that command over 80% of new issuance, it is looking into this. All pre!issuance work is conducted by Tinkoff.ru, and the cost savings due to online processing are passed on to the borrower through slightly lower interest rates. All documents can either be submitted online or collected by one of Tinkoff’s 1,400 couriers, with physical KYC done at the point of signing. Tinkoff only takes commission on mortgage completions and is hoping for at least R20 bln in mortgage sales in 2017, with a target of R0.3!0.6 bln in net income by 2019 (only 5!10% of non!credit net income, which seems low to us). Obviously, the greater the scale, the more pricing power for Tinkoff.ru. Again, Tinkoff has a great brand and a lead generation machine working in its favor, but the management has admitted that this has by no means led to easy conversions. In Russia, the large state banks account for about 80% of the mortgage market, so this could be a tough market to crack. However, if all goes according to plan, the brokerage model will be used for travel insurance, car loans and cash loans too.

█ Direct insurance. The management acknowledges it is still very tough to make money in the Russian insurance market, particularly in car insurance, which is currently dominated by offline insurer partnerships with car dealerships and insurer agent networks. Moreover, there is very limited market infrastructure (such as a centralized database of claims) for what is a business based on risk assessment. Despite all this, it seems to us that there is a lot of potential for online insurance in Russia, given that the product is well suited to being bought online (as experience in the UK shows) and the relatively high level of internet penetration in Russia. If anyone can make headway in online insurance, it is Tinkoff. At the moment, the focus is on proprietary voluntary car insurance, while a potential move into insurance brokerage is being considered. As for life insurance, which is a market that may be ripe for development in an environment of lower inflation and interest rates, the management has decided that this is not a focus for the business in the near term.



Non!credit related business lines Product Launch Details

Broker platformMortgages May ’15 Eight partner banks (incl. DeltaCredit, UralSib and Absolut Bank); 20!25k

applications generated per monthAll pre!issuance communication with clients is done by TinkoffOperationally expected to break even by end 2017

Retail securities Oct ’16 Tie!up with Russian brokerage BCSTrading platform is incorporated into Tinkoff's online bank

Direct insurance 1H17 (exp) Initial focus on voluntary car insurance (CASCO); plans for a range of products from leading insurers as well as Tinkoff's own insurance products; 2!3 year ramp!up expected

Cash loans 2017 (exp) Tinkoff to sell point!of!sale cash loans of partner banks

Proprietary productsSME services 2H15 Non!credit related services (current accounts, employee card programs, consulting

services, tax payments, accounting, financial analysis); aiming for 50k accounts by end 2016; no plans to move into creditOperationally expected to break even in 1H17

Acquiring May ’15 Online acquiring for businesses; 2.0!3.5% commission depending on turnoverOnline and mobile payments 2Q16 Online payments (e.g. utility bills, traffic fines) are accessible to non!Tinkoff

customers (currently 250k "light customers" with a Tinkoff ID)

Source: Company, Sberbank CIB Investment Research



Moscow Exchange

Why is Moscow Exchange in our Fintech report?

As the pre!eminent financial marketplace in Russia, Moscow Exchange (MOEX) can be affected in various ways by fintech developments. It is already actively looking at blockchain applications and implementing other fintech innovations.

Mixed implications of blockchain

A technology like blockchain can impact MOEX’s business in different ways. On the one hand, there are parts of the business that can clearly benefit from blockchain solutions, and we look at one area, e!proxy voting, in more detail below. MOEX is actively looking at the potential this technology offers. Last year a National Settlement Depository (NSD) blockchain working group was set up to look at potential applications of blockchain, including in securities settlement, financial messaging and biometric identification. MOEX is also a member of the Hyperledger consortium and the CBR’s blockchain working group.

On the other hand, in the longer term, some potential uses of blockchain in transferring assets (for example, securities) by way of peer!to!peer (P2P) solutions, such as we see with SETL in the UK, could ultimately challenge the centralized nature of the business. However, we do not see any major near!term risks of disintermediation to some of the key institutions of the Russian financial system which MOEX operates, such as to the National Clearing Center, NCC, and the NSD. Trading infrastructure in Russia is highly centralized and there are high barriers to entry. Moreover, an argument can be made that the current infrastructure works well, although obviously with the associated costs for market participants.

E!proxy voting on blockchain

Blockchain can increase efficiency by improving high!touch, fragmented processes, such as corporate actions involving several parties (e.g. issuers, the NSD, custodians, brokers and investors). E!proxy voting is one such solution.

E!proxy voting allows for electronic interaction between securities’ holders (or rather their custodians, hence the “proxy”) and issuers to exchange information and documents. The NSD introduced e!proxy voting for bonds in 2014!15 (not on blockchain at this time) and for stocks earlier this year.



Blockchain!based e!proxy voting

Blockchain

a

c

b

d

Votingresults

Registerof votes

Proxy voting

Resultscalculation

Bondholder

Bondholder

Bondholder

Verify

Proxy voting

NB!1

Proxy voting

NB!1

NSD

Source: Company

HOW E!PROXY VOTING WORKS

MOEX’s blockchain!based e!proxy voting prototype enters voting instructions into a distributed database which is accessible to all members of a chain of custodian nominee accounts simultaneously.

A bondholder (this has not been trialed for equities yet) votes through their personal account held by their custodian, using a digital signature. The custodian enters this vote into the blockchain, accompanying it with their own digital signature. To confirm that the vote has been received, the custodian provides the securities’ holder with the number assigned to their vote in the distributed database. The record of the vote is then passed on from one custodian to another until it reaches the NSD, which holds the golden copy. As voting is completed, the system automatically calculates the results and publishes them onto the blockchain. Cryptography ensures the voting process is secure.

MOEX has highlighted several advantages it found during testing, including:

█ Increased trust thanks to the full transparency provided by the ability to access the system through APIs to check the voting status and results.

█ Reduced operational risk for custodians thanks to the elimination of message exchange and automatic verification of balances and votes to be counted.

█ Full auditability and traceability for all participants, including the regulator.

█ The ability to extend the technology to other types of e!voting procedures.

There is still a fair way to go before this system is actually implemented, with pilot projects and security and legal hurdles still to come, but so far the trial results have shown promise.



Moscow Exchange as fintech innovator

MOEX has always been a financial technology company. The core business of a modern exchange is all about the continuous pursuit to provide the fastest possible trading and settlement of securities, minimizing down time and ensuring against cyberattacks and fraud, all of which requires the most advanced and robust IT platforms.

MOEX has a unique business model, compared with global peers, as its product offering includes on!exchange forex trading and money market operations.

In 2012, MOEX granted direct retail and corporate access to its FX market, which was exclusively for banks previously, shaking up the FX market. Operations were conducted through brokers, which allowed for significant savings on the back of direct FX buying on the exchange instead of through banks. Although the general population still prefers to use banks for their FX exchange needs given the easier access, the pressure from the direct access has undoubtedly narrowed FX spreads at many banks.

The latest initiative of the exchange, granting the largest Russian companies full direct access to MOEX (without going through brokers), may further erode bank commissions in the business. The current plan (which is yet to be approved by regulators) would allow Russian corporates with more than R1 bln in capital (about 50 companies) to trade directly on the FX market without leverage from the start of next year. Companies with more than R50 bln in capital (less than 10 companies) would be allowed to use leverage. If the initiative is approved by the Central Bank and proves successful, MOEX may also consider allowing corporates to place short!term deposits on the exchange, which poses a risk to banks’ cost of funding.



How Fintech Fits Into Financial Services in Russia

In the first section of this report, we looked at some of the major global trends in terms of the impact of fintech on retail banking across areas such as digital banking, payments, P2P payments and money transfers, P2P lending, online lending, digital wealth management and aggregation.

Having profiled some the leading names in fintech in banking (Sberbank and Tinkoff Bank) and Moscow Exchange, in this section we cast an eye over some of the names hovering a bit below the radar in the Russian fintech space.

The nuances of Russian fintech

First off, we offer a few observations on some of the broad characteristics of Russian fintech.

█ The level of financial literacy in Russia is generally low. Cash still dominates, although non!cash transactions are steadily growing, and the rapid growth in the adoption of online and mobile banking suggests there is potential for companies that can offer a clearly superior online customer experience. But it is not going to be easy going given that some well!established incumbents are among the most innovative companies, which suggests collaboration may often be the best route.

█ The main retail banking impact from fintech startups can so far be seen in the areas of microfinance, payments and mobile acquiring. The former is due to low barriers to entry and the ability to disrupt traditional players with a faster, more convenient online service. In payments, disruption has arisen given the high level of cash transactions in the economy and the desire for anonymous payments, which spawned strong e!wallet growth stories several years ago but which is fading as KYC regulation has tightened up and banks have developed much more sophisticated online banking platforms. Mobile acquiring is quite a vibrant area as the fast!growing Russian e!commerce market has been creating natural demand for convenient forms of payment on delivery as an alternative to cash.

█ The online remittance market could well be an area for potential disruption given that Russia is one of the leading countries in terms of remittance volumes globally, although in Russia this remains a cash!driven business in which many customers are low income without online access.

█ While digital banking through internet and mobile is now de rigueur, there are few examples of pure play digital banks emerging. Tinkoff Bank has of course been doing this for years, Touch Bank and Rocket Bank are more recent examples, but both are very small scale, and there are also some online SME banks emerging (Tochka Bank and Modulbank). What does not help the emergence of new digital banks is that market leaders such as Sberbank, VTB 24 and Alfa Bank typically have strong online and mobile banking platforms.

█ Several segments which fintech has disrupted in retail banking in Western markets are virtually nonexistent in Russia. For example, P2P lending has never got off the ground given structurally high deposit interest rates, the preference for real estate as an alternative to deposits, and a general lack of trust in lending to peers. But in fairness, even in developed markets, much of the P2P lending scene is now institutionally!funded.

█ Another example for which progress has been slow in Russia is online lending, given the regulatory regime pretty much forbids the issuance of credit without physical customer verification. Digital wealth management services are also absent given the lack of a material retail investor base in Russia, although banks such as Sberbank and Tinkoff Bank are now starting to roll out simple retail brokerage services online.



█ While there are online financial product comparison sites, such as Banki.ru and Sravni.ru, it is far too early for online aggregation or personal financial management services. Again, a general low level of trust from customers about sharing data would in our view limit the growth potential for aggregation, other than through some of the leading banks.

█ We have spoken to both sides of the fintech fence in preparing this report, in terms of both startups and private equity/venture capital investors. Generally there is the feeling that fintech development in Russia will be more about collaborating with big players such as leading banks rather than challenging them, which makes sense to us given the strong digital offerings of some of the leading banks and the challenges of developing scalable and sustainable customer!facing businesses. On the VC/private equity side, one of the common complaints has been that fintech companies in Russia are often just too small, that there is a shortage of fintech businesses that have any scale, which from the fintech side of the fence probably feels a bit like chicken!and!egg.

The regulatory backdrop

The CBR can generally be thought of as a fairly conservative regulator that proceeds with care in terms of framing the regulatory landscape but at the same time still tries to keep up with global trends, as we have seen, for example, in recent years with the introduction of Basel 3 in Russia.

In our view, this is more or less how one can describe the CBR’s rhetoric toward the fintech space. Two years ago, fintech and blockchain were very niche words, but the CBR has already launched a blockchain prototype and tested it with banks.

ATTITUDE TO BLOCKCHAIN AND BITCOIN

At the start of 2014, the CBR warned the population, companies and banks against using bitcoin. This was followed by the Finance Ministry preparing draft legislation involving fines for issuing cryptocurrency. Since this time, however, the regulatory rhetoric has been gradually softening and the most recent communication from CBR Deputy Governor Olga Skorobogatova (who is in charge of IT, payments and fintech) has been that a national cryptocurrency may be a secure instrument. She has also promised to come up with a more detailed regulatory stance toward cryptocurrencies within the next few months.

Blockchain technology has hitherto sparked more constructive interest from the regulator than bitcoin. The CBR has set up a working group of the biggest banks to study and produce blockchain prototypes. The first one was used for the transmission of simple financial messages between banks. The second prototype, Masterchain (based on Ethereum’s platform) is intended to create a communication network that will allow for the exchange of client data and to set up various financial services. The first test transactions on Masterchain have been conducted by Sberbank, Alfa Bank, FC Otkritie Bank, Tinkoff Bank and QIWI.

FINTECH FACILITATION

The CBR is setting up a fintech association to help banks develop fintech solutions and to find an appropriate regulatory regime. So far, 10 financial companies have agreed to participate and invest in it. Its goal would be to cultivate knowledge and expertise in fintech to create platforms that would be used by the entire market.

Another CBR initiative is the idea of creating a regulatory sandbox for banks that would allow for testing various new solutions without the risk of being punished for breaking existing regulatory norms. That would also serve as a base for tailoring future full!scale regulation and changing legislation if necessary.

The CBR has also come close to solving one of the banks’ and fintech’s main pain points: client identification. Under the current legislation, each financial service provider has to fully identify



clients via the presentation of a passport in person. Moreover, clients are required to carry this out for each financial institution that they interact with, as there is no central database of client IDs to which banks can have access. The CBR’s suggestion is to use a person’s registration on state services website Gosuslugi as a unified client ID that could be used for remote identification. This is a joint project between the CBR and Communications Ministry and is planned for roll out in 2017.

Digital banking

There are about 90 mln people with banking access in Russia that are serviced by about 550 retail deposit taking banks. All of these banks, with the exception of Tinkoff Bank, mainly service their clients in physical branches, typically accompanied by some sort of call center service, but few of them beyond several of the leading names offer well!rounded digital online banking services.

According to the CBR’s financial access survey, about 39% of adult population or 46 mln people have access to digital banking in some form:

█ 31% (36 mln) have access to internet banking.

█ 34% (40 mln) have access to mobile banking, which is further divided between banking via mobile app (24% or 28 mln) and SMS banking (29% or 35 mln).

However, not all people are actively using digital banking services. For example, just 24% of adults used remote banking to make payments during the past 12 months (so only 60% or so of those who had access).

Markswebb Rank & Report, a Russian e!finance analytical agency, conducts annual surveys on internet banking usage in Russia. The latest survey showed that two thirds of internet (online) banking users are using just one bank’s internet platform, while another quarter are using two internet banks. As for mobile banking users, three quarters are using one mobile app and 18% are using two.

The ranking of most popular digital banking providers in Russia reveals Sberbank’s overwhelming dominance: about 80% of all digital banking users are utilizing its solutions. The second most popular bank, VTB 24, has just 8!9% using its solutions. Tinkoff Bank, despite its relatively small size (for example, it is only the 29th largest retail deposit taker in Russia) occupies fourth place after Alfa Bank, with 5!6% penetration among mobile/online banking customers. While we generally take these surveys with a pinch of salt, this data more or less squares with figures from Google in Russia that places Sberbank, VTB 24, Tinkoff Bank and Alfa Bank as the top four banks in terms of brand interest growth.

Top 10 internet banks, share of total surveyed internet bank users

81.8%

9.1%

7.1%

6.2%

3.7%

3.4%

2.6%

2.5%

2.3%

2.0%

0.0% 20.0% 40.0% 60.0% 80.0% 100.0%

SberbankVTB 24

Alfa BankTinkoff Bank

Russian Standard BankHome Credit & Finance Bank

Bank of MoscowOtkritie Bank

PromsvyazbankRaiffeisen Bank


Top 10 mobile banks, share of total surveyed mobile bank users

78.0%

7.9%

5.7%

5.3%

2.5%

2.2%

1.9%

1.7%

1.5%

1.5%

0.0% 20.0% 40.0% 60.0% 80.0% 100.0%

SberbankVTB 24

Alfa BankTinkoff Bank

Bank of MoscowRaiffeisen Bank

Home Credit & Finance BankMTS Bank

RosbankRussian Standard Bank


So are there any other interesting banks beyond the leading digital banking propositions of Tinkoff Bank and Sberbank (which we cover in separate chapters)?



ALFA BANK

While it is a universal bank and not a pure online bank, Alfa Bank has consistently been the other name alongside Sberbank and Tinkoff Bank that has come up in our conversations about leading banks in Russia in the fintech space. We met with Alfa Bank’s CEO, who stressed that the keys to a successful digital banking operation are having a digital mindset throughout the bank, making the best possible use of data, and being very good at integrating security and simplicity. Alfa Bank operates its own in!house fintech research hub, Alfa Lab, which develops digital products that can be rolled out across the bank. It also conducts an annual AlfaCamp for fintech startups. One of the areas Alfa Bank is focusing on is trying to think about incorporating financial decisions as part of broader customer experiences.

ROCKET BANK

This digital startup was launched about three years ago as a standalone mobile banking app (somewhat similar to Simple or Moven’s solutions in the US) that allowed seamless digital banking exclusively on iOS. Until December 2015, it was using the banking back end of Interkommerzbank, but following the removal of the latter’s license, Rocket Bank was acquired by Otkritie Bank (which interestingly also has its own mobile app). Rocket Bank has gained some popularity primarily among young, affluent (typically hipster) customers but remains a niche product, offering only debit cards and deposits. It does not have a desktop application and does not provide credit products. Rocket Bank was one of the pioneers of providing client support through in!app chat, which is now becoming widespread among Russian banks.

TOUCH BANK

Touch Bank is a startup launched by OTP Group in April 2015 in Russia with a view to developing the business model of a purely digital bank that could, if successful, ultimately be rolled out across the countries in which OTP Group has a presence. Touch Bank does not have its own banking license but is rather working off the balance sheet of OTP Russia, and it currently offers a current account, short!term deposits, cash loans and credit cards. We met with the management, whose ambition broadly seems to be to compete with Tinkoff Bank for young, affluent clients who want a fully digital banking service. In our view, Touch Bank has launched an interesting proposition. For example, it offers just one card that can serve both as a debit and credit card, with a credit limit automatically kicking in when a client’s funds on the debit card are insufficient. There is also an option to switch between debit and credit accounts in the mobile app at any time. Underwriting for credit is done at the point of customer acquisition, after which, if approved, Touch Bank offers a credit line that can be allocated between an instalment cash loan and a credit card (with the same interest rate), which can be shuffled at any time depending on the customer’s credit needs.

Another interesting feature is the “card!on!card” function, which allows customers to connect up to five cards from other banks to their Touch Bank card, and to set up rules that redirect payments to these cards based on how much funds they have or on a specific type of transaction/merchant. This can prove handy for cashback hunters who bring multiple cards to maximize the benefits of the cashback rules of various banks. Touch Bank is just over a year old and has already built a decent base of around 100,000 clients with R3.5 bln deposit portfolio and R1.5 bln open credit lines.

Digital SME banks

An area of increasing fintech activity is online SME banking services, with disruptors emerging looking to provide faster and more convenient online services for Russia’s 2 mln or so SMEs.

TOCHKA BANK

Tochka Bank is an online SME platform created by FC Otkritie Bank in 2015, and is within the top 10 companies servicing SMEs in Russia (it works off the balance sheet of FC Otkritie Bank, which is itself part



of Russia’s fifth largest banking group). The core of Tochka Bank’s team came from Bank24.ru, which was part of the Probusinessbank group prior to having its license revoked in 2014. The bank’s IT platform was highly regarded in the industry, but poor internal controls and compliance caused Bank24.ru to lose its license. FC Otkritie bank hired several of Bank24.ru’s key staff and subsequently launched Tochka Bank. It now has around 40,000 SME customers and offers a range of online and mobile services, including online deposits, FX operations, card payment acquiring, payroll projects and integration with leading accounting services, albeit not lending. Having a sizable parent behind it should be supportive for Tochka Bank, although FC Otkritie Bank has a large number of different entities working within the group and it remains to be seen whether Tochka Bank can thrive long!term in this environment.

MODULBANK

Modulbank was created by Andrei Petrov, Yakov Novikov and Oleg Laguta, who had previously worked on Sberbank’s SME projects. It was founded in 2014 on the basis of Regional Credit Bank and only in 2016 fully transformed into a specialized online SME servicing bank using its current name. According to Banki.ru, the three founders own 7.5% each, while the main beneficiary is Uniastrum Bank owner Artem Avetisyan with a 35% stake. Sovcombank owns the remaining 24%. Modulbank is pretty small, ranked 240 in Russia with a balance sheet of R8.5 bln ($130 mln) and only about R1.4 bln corporate current accounts. Despite its digital focus, the bank also has physical footprint: it has two offices in Moscow and Novosibirsk and 20 mini!branches at business centers in Russia’s biggest cities with a plan to open 30 more branches by year end. The bank reported around 19,000 clients as of mid!2016 and the plan is to increase that number to 50,000 by year end. According to the managers, the current IT capacity allows 100,000!200,000 SME clients to be serviced. Apart from core banking online services, Modulbank offers its own online accounting solution, as well as online legal services and a business assistant.

Microfinance

The microfinance market in Russia is much smaller than traditional lending. According to the CBR lending survey, 30% of the adult population has had a bank loan, but only 2% have borrowed from microfinance companies.

In 2015, microfinance companies lent R117 bln (about $1.9 bln at the current exchange rate) to retail clients and as of 2Q16 their retail portfolio amounted to R60 bln. Hence, their whole portfolio is about half that of Tinkoff Bank’s and 180 times smaller than Russia’s retail lending market (R10.7 trln).

However, given low entry barriers (minimal regulation and capital requirements) as well as high lending yields, this market has attracted new ventures that are trying to disrupt traditional players (both scrupulous and unscrupulous) using new technologies such as big data and social networks.

Unlike in the US, UK or China, in Russia there is no visible organized peer!to!peer lending P2P market. Its development is hindered by the presence of other investments with decent yields (deposit rates were only recently in the 15% area) and a lack of institutional mechanisms of credit collection that could be trusted by people.

There are about 3,500 microfinance companies in Russia, but here we look at just a few of them that are doing things differently, in our view.

DOMASHNIYE DENGI

Domashniye Dengi is one of the longstanding leaders on Russia’s microfinance market. It was founded in 2007 by Evgeny Bernshtam and was the first microfinance company to raise public debt. It has about 350,000 clients across Russia and lent R2.5 bln to clients in 1H16. While the company has a web and mobile presence, its primary distribution channel is a network of 4,500 agents who deliver cards with pre!issued loans across Russia.



MILI

MILI is an online microfinance lender that was launched in 2012. It represents a new generation of microfinance lenders that are cutting costs on the back of lean digital processes while also using advanced scoring methods to keep asset quality under control. The company has built its scoring model in!house. This model incorporates a proprietary decision!making engine that aims to maximize the NPV per customer. One of the main features of this service is the use of social network data in its scoring process, used in conjunction with traditional credit bureau data. Anyone who wants to get a loan at MILI needs to allow access to their online friends list, which, according to MILI’s founder, Levan Nazarov, appears to be a good predictor of people’s default probability; and every second customer has a friend on social media who has taken out a loan.

As for distribution, MILI uses Euroset’s branches to deliver cards with approved credit in order to obtain a signed credit agreement and follow Russian KYC rules (which many microfinance companies omit to do) in order to later be able to take customers in default to court if needed, or to sell exposures to collectors with a proper paper trail.

The business is fully capital funded (R250 mln; which leaves it well!positioned as the CBR is tightening capital requirements for microfinance lenders), has around 70,000 active customers with an average loan size of R8,000 and became profitable in just over three years. The plan is to keep testing the robustness of the business model before potentially expanding into other areas of retail banking.

REVO

Revo was launched in 2012 and focuses on delivering instant and paperless pay!later services for online and offline retailers. It aims to do this through leveraging the latest mobile, cloud and data technologies. The company works with 40 national retailers, primarily in footwear, children’s’ goods, grocery, clothing and medical services, and has financed 1.5 mln purchases in Russia in more than 100 cities.

Revo’s solution for merchants delivers an individual purchase limit at POS within seconds for new and repeat shoppers. The company has implemented a fully digital underwriting process, tapping a range of traditional and new data sources, including credit bureaus, social networks and payment services. Customers can pay for their purchases in equal installments over several months (typically three or six instalments), using any of the available payment services in the country, including banks, cards, shops, and terminals. Customers can pay the face value of the goods, with the vast majority of loans subsidized by the merchant on the interest side (which is where Revo makes its revenues), so effectively Revo typically bears the credit risk for the amount of the purchase. The proposition Revo offers its merchant partners is more traffic, conversions and bigger basket sizes.

Revo delivers a similar pay!later solution commonly found in Brazil, Turkey, and Israel with a few important technological differences. Revo’s solution is fully digitized and has eliminated the need for any plastic bank cards, card acquiring, and traditional bank application and approval processes. The likes of Affirm and Klarna offer a pay!later solution in the US and Europe but only for online stores. Revo delivers a single solution meeting merchants’ needs in any channels. While there are no direct peers in Russia, a number of POS banks offer interest!free POS lending, but this is typically in bigger ticket segments such as electronics, not the retail segments which Revo serves.

Online payments

One of the most talked about areas of fintech in Russia is online payments. Unfortunately, however, the data on online payments in Russia is scant and may not be fully reliable. Several sources suggest that total volume of online payments can be estimated at around R600 bln in 2015.



A recent TNS survey of internet users revealed that digital banking through desktop or smartphone is the most preferred option for online payments (80% of users), followed closely by banking cards (79%). E!wallets are used by 62% of respondents, while SMS payments are carried out by 42%.

We do not have the data of how this preference has changed over time, but one question this data throws up is what the value proposition is nowadays for e!wallets given that online banking platforms are becoming much more advanced and can easily match e!wallets in terms of security. The most common answers we have heard here are the anonymity offered by e!wallets as well as the ability to make and receive payments for gray economy work without disclosing bank details. But the regulator is increasingly trying to clamp down upon the anonymity of e!wallet transactions.

Preferred online payment options

80%

79%

62%

42%

0% 20% 40% 60% 80% 100%

Online banking

Bank cards

E!wallets

SMS payments

Source: TNS, Yandex.Money

Most popular online payment options

72%

35%

30%

30%

28%

14%

13%

10%

5%

2%

0% 20% 40% 60% 80%

Sberbank OnlineYandex.Money

WebMoneyPayPal

Visa QIWI WalletAlfa Click

VTB 24Tinkoff Bank

Russian Standard BankOther internet banking


Popular online payment categories

77%

66%

60%

59%

37%

34%

33%

31%

14%

0% 20% 40% 60% 80% 100%

Mobile top!up

Online shopping

Bills

Money transfer

Event tickets

Fines and taxes

Transport tickets

Loans

Education


E!commerce remains a big potential driver for online payments growth. Currently, the majority of domestic Russian e!commerce involves ordering goods online but then paying on delivery, primarily in cash, though card payments are also becoming popular with the help of mobile point of sale (mPOS) devices. As the population gains trust in the reliability of domestic online shopping, online payments via cards, e!wallets or online banking (like Sberbank Online or Alfa Click) are poised to grow. By contrast, cross!border e!commerce (such as through the most popular online shopping site in Russia, AliExpress) purchases need to be paid for upfront, typically through bank cards, e!wallets, or online banking.

QIWI

QIWI can reasonably claim to be one of the fintech pioneers in Russia. Having been established in 2007 as an operator of a nationwide network of physical payment kiosks, it launched its e!wallet the following year, subsequently partnering up with Visa, and now has more than 16 mln active users (defined as used in the past 12 months). Its physical network consists of 160,000 kiosks and terminals, which are actively used by about 60 mln customers. Russia remains a highly cash!dependent economy, but there are clear long!term threats to this kiosk business from tighter regulation relating to AML/KYC, as well as increased competition from bank ATMs (although many



are typically located within bank branches) or online services, which can offer lower fees for many transactions such as top!ups and bill payments.

The thrust of QIWI’s efforts going forward would seem to be on expanding its retail banking presence. Its latest corporate presentation refers to offering funds as a “bank for un! and under!banked.” To this end, we note the recent acquisition of small online POS lender PlatiPotom, which specializes in post payment solutions for e!commerce and offline, credit scoring and risk management and which suggests a foray into POS consumer credit. Some form of payday lending may be another possible option. It is worth noting that QIWI has long had a full banking license. QIWI is expected to reveal more details about its strategic shift in the near future. In its favor, QIWI no doubt has access to a solid customer base and good data in terms of customer payment habits, but of course, executing a transition from payments to credit, if this is the case, would not be an easy thing to pull off in what is a pretty competitive market.

Another angle that QIWI is also looking at is how it can utilize its extensive merchant relationships (50,000 merchants) through possibly at some stage starting to provide some online SME banking services. But again, this is a competitive area, with Sberbank gearing up here, Alfa Bank already strong, and online players such as Tochka Bank, Modulbank and Tinkoff.ru also present.

QIWI is also actively looking at blockchain technology and is a member, along with several of Russia’s largest banks, of the CBR’s blockchain working group, as well as the international R3 blockchain consortium.

YANDEX.MONEY

Yandex.Money is another leading fintech player and is one of the largest online payments services providers in Russia. It was developed by Russia’s leading search engine, Yandex, and is now a joint venture between Yandex and Sberbank (which acquired 75% in 2013).

Yandex.Money has two main business lines. Its B2C offering is built around its e!wallet, which has 25 mln users (although the company does not disclose active users). This service has become popular primarily as a vehicle for online shopping, P2P payments and payments for services (utility bills and fines). These segments are the main revenue generators on this side of the business. Yandex.Money also recently launched mobile payment by QR code through its e!wallet.

Yandex.Money’s other main business line is Yandex.Checkout, a B2B solution for online merchants that has become one of the leading online payment aggregators in Russia. Here, it offers an API plug!in for online shops to accept various payment options: credit cards, e!wallets, online banking, mobile billing, and cash via 200,000 cash!acceptance points. Currently, some 76,000 online merchants use Yandex.Checkout.

So how does it benefit from its heavyweight parental links? It offers one!click payments through Yandex Search, which is Russia’s most popular search engine, as well as plug!ins to a range of Yandex apps such as Yandex.Fines, Yandex.Parking and Yandex.Fuels. On the Sberbank side, certain merchant relationships that Yandex.Money has can be integrated into the Sberbank Online platform.

Online comparison sites

As is the case in many parts of the world, Russia has not seen the emergence of financial aggregator sites. There are, however, some popular online financial product comparison sites, including Banki.ru and Sravni.ru. On Banki.ru, alongside fairly standard deposit and credit comparison offerings, the site also offers pay!for services such as obtaining credit histories and ratings, as well as online financial forums. The site makes its money from lead generation for banks. Sravni.ru has a slightly different offering in that it also focuses on online general insurance, such as car, health and travel insurance.



Mobile acquiring

There are some interesting things happening in the mobile POS space, although we have little visibility on the scale or financials of these businesses, in what are typically high volume, low margin segments.

The fast!growing Russian e!commerce market has been creating natural demand for convenient forms of payment on delivery as an alternative to cash. Mobile POS payment devices are one such example of a disruptive solution not necessarily purely in the online space. Such a device can be as small as a matchbox and can be easily attached to a smartphone or work over Bluetooth. This allows couriers to accept payments for various goods on delivery, which is good for clients as it combines the comfort of and security of paying by card (terminals support EMV chip protection) with the assurance of on!delivery payment (as opposed to prepayment online).

There are three main players in this market that were all set up around 2012.

2CAN

2Can is one of the leading mPOS device providers in Russia, with R3.4 bln card payments turnover in 2015. In 2015, 2Can merged with another mPOS player, ibox, and now claims around 60% of the mobile acquiring market. Among the investors in 2Can are Inventure Partners, Almaz Capital and ESN Group. 2Can currently partners with 29 Russian banks and their number is growing. 2Can has sold a total of 30,000 mPOS devices at prices starting from R4,000. Almost half of its card volumes are in regions outside Moscow and St Petersburg. Among its clients are Ozon.ru, one of the country’s largest online retailers, and Lamoda, Russia’s biggest online clothing retailer. It also provides white label service for Yandex.Market.

PAYME

PayMe was launched in October 2012 and has attracted $3 mln of angel investments in total. It is present in Russia, Kazakhstan, Ukraine and Belarus. In Russia it operates in partnership with Visa, Alfa Bank and Beeline. According to its website, it has 16,000 clients in Russia and the CIS who are using 34,500 devices with $2.5 mln monthly card turnover.

LIFEPAY

LifePay was launched in 2012 and its major shareholder is Life.SREDA (which was the VC subsidiary of Probusinessbank but relocated to Singapore after its license was revoked). One of the differences compared to its competitors is its somewhat broader product line. In addition to mPOS acquiring, the company offers a stylish sales register, sales and business analytics app, online acquiring and has recently launched payments for goods on delivery using just a mobile number.

Crowdfunding

In Russia, crowdfunding (like P2P lending) is still very much at an early stage. There are several startups in this area. Planeta.ru helped fund its own startup in 2011 and to date has helped to raise over R0.5 bln for 2,200 successful projects (with every third project apparently being a success). The most popular areas are social, music and video. BOOMSTARTER was launched in 2012 and has so far helped bring to life 1,200 projects with a record project gathering R3.9 mln (an inflatable sofa for outside use). StartTrack functions as a crowdfunding platform for SMEs to attract retail funding. In two years, StartTrack has helped 320 companies attract R570 mln of investments via a pool of 1,200 investors. In 1H16 its turnover was R258 mln for 19 business projects.



Fintech landscape

Mapping the Russian fintech landscape is a testing business, given there are a large number of often very small companies out there. Below, we highlight 25 or so that at least have some reasonable funding behind them.

Select fintech companies in Russia

Founded Business Activity Funding/ownership Web link

Online banksModulbank 2014 B2B Online SME bank Owned by Artem Avetisyan (35%), Sovcombank (24%) and

three founders (7.5% each)modulbank.ru

Rocket Bank 2012 B2C Online banking app 100% sold to Otkritie in 2016 rocketbank.ruTochka Bank 2015 B2B Online SME bank Set up by Otkritie tochka.comTouch Bank 2015 B2C Online retail bank Set up by OTP Group touchbank.com

Mobile acquiringLifePay 2012 B2B mPOS terminals $2.6 mln in seed financing from Life.SREDA in 2012 life!pay.ruPayMe 2012 B2B mPOS terminals $3 mln funding through angel investors pay!me.ru 2Can 2011 B2B mPOS terminals $8.3 mln funding from three investors: Almaz, ESN Group,

Inventure Partners2can.ru

Evotor 2016 B2B Sales register and POS combined solution for retailers

JV of Sberbank, ATOL and Andrei Romanenko evotor.ru

Online payments aggregators (acquiring and processing)Yandex.Checkout 2013 B2B Online payment aggregator,

payment processingSet up by Yandex.Money kassa.yandex.ru

Robokassa 2003 B2B Online payment aggregator robokassa.ruDengi Online 2006 B2B Online payment aggregator,

payment processingReceived $2 mln from QIWI dengionline.com

RBK Money 2002 B2B Online payment aggregator, payment system

Group of private investors and managers rbkmoney.com

PayU 2011 B2B Online payment aggregator Global service, owned by Naspers payu.ru

MicrofinanceDomashniye Dengi 2007 B2C Microfinance Founded by Evgeny Bernshtam domadengi.ruMILI 2012 B2C Online microfinance $6.1 mln in two rounds, with $5 mln in series A in 2013 mili.ruPlatiza 2011 B2C Microfinance $3 mln in series A from Flint Capital and Prostor Capital platiza.ruMoneyman 2011 B2C Online microfinance $9 mln in two rounds (most recently $6 mln from Emery

Capital and Vadim Dymov for 20% stake)moneyman.ru

Revo+ 2012 B2B, B2C Installment payments service for retailers

Group of private investors, Vostok Emerging Finance revoplus.ru

PlatiPotom 2013 B2B, B2C Installment payments service for online stores

Acquired by QIWI in 2016 platipotom.ru

Vdolg.ru 2011 B2C P2P lending $2 mln from Runa Capital in series A in 2013 vdolg.ru

CrowdfundingPlaneta.ru 2009 B2B, B2C Crowdfunding $1 mln in series A funding in 2013 planeta.ruBoomstarter 2012 B2B, B2C Crowdfunding Group of private investors boomstarter.ruStartTrack 2013 B2B, B2C Marketplace for SME funding by

retail investorsSet up by IIDF (Internet Initiatives Development Fund) starttrack.ru

Comparison sites/marketplacesBanki.ru 2005 B2B, B2C Online comparison of banking

services60% owned by founders, 40% by Russia Partners (invested $6 mln in 2013 for unknown stake)

banki.ru

Sravni.ru 2009 B2B, B2C Online comparison of financial services

Founded by Albert Popkov, Tinkoff Digital is one of shareholders

sravni.ru

Note: Excluding Sberbank, Tinkoff, Moscow Exchange, Alfa Bank, QIWI and Yandex.Money

Source: Crunchbase, Rusbase, Companies, Sberbank CIB Investment Research

How banks are positioned versus fintech startups

Here we present a SWOT analysis of how Russian banks are positioned relative to potential disruption from fintech startups.



SWOT analysis of banks’ position relative to potential fintech disruption

Strengths

! Client base. Large base of identified (full KYC) customers with cross!sell potential.! Infrastructure. Branch/ATM/POS infrastructure is largely built and easily accessible.! Trust. Population trust its money to banks that are backed by deposit insurance.! Barriers to entry. High regulatory and capital barriers keep newcomers away from banks' core risk!taking business.

Weaknesses

! Customer service: Traditional bank processes involve a lot of paperwork and mandatory branch visits, which is not convenient for the customer! IT systems are inflexible: This makes them hard to adjust in real time and to launch new products quickly! Tight regulation: Makes it hard for banks to think outside the box! Low capitalization of banks: May prevent investing in crucual technologies to survive

Opportunities

! Keeping last mile contact with client: Retaining client focus via launching tailored mobile apps, marketplaces, launching new services through open APIs.! Cost!cutting: Digital penetration can bring cost efficiencies with respect to closing down physical infrastructure.! Big data: Banks' access to important client transaction data can make them valuable partners for all retail businesses. ! Underpenetration: Banks may be among the most advanced institutions in Russia's underpenetrated markets, hence providing time and scope for retaining and broadening client base.

Threats

! Disintermediation: Rollout of direct market access and P2P lending (though banks in Russia have years before it may start really growing).! Loss of margin in traditional banking products: Banks' juicy commisions on FX and money transfers could be gradually eaten up by new platforms.! Becoming back end: New services like Apple Pay risk partially removing banks from client!facing communication.! Cybersecurity: Breaches can bring losses and undermine trust in banks.


The risks of disruption for conventional banking business in Russia The risks of disruption for conventional banking business in Russia

Source of disruption Risk of disruption

Transactional businessFX operations Direct platforms (e.g. exchanges/TransferWise) MediumCard payments Mobile/epayments (e.g. Apple Pay/AliPay) Medium/HighP2P payments/money transfer fees Internet companies (e.g. PayPal/Facebook) Medium/HighSettlement transactions with corporates Blockchain Low

Lending/deposit businessConsumer loans P2P lending (e.g. Lending Club, Zopa) Very lowMortgages Online lenders/marketplaces (e.g. Quicken Loans/Tinkoff) LowCorporate loans Crowdfunding/online SME lenders (e.g. Kickstarter, Kabbage) LowCorporate deposits Direct platforms (e.g. exchanges) LowRetail deposits P2P funding/retail brokerage (e.g. Lending Club, Nutmeg) Low


Ways to play the Russian fintech space as an investor

For investors, there are different ways to play the fintech space in Russia.

LISTED SECURITIES

The three main companies profiled in this report are all of course listed equities: Sberbank (not rated), Tinkoff (BUY; TP: $8 per GDR) and Moscow Exchange (BUY; TP: R138). The other listed equity name mentioned is QIWI (covered by our TMT team, BUY; TP: $15.08).

On the debt side, Alfa Bank has a number of outstanding external and domestic bond issues, of which we currently favor the Alfa 21 Eurobond.

VENTURE CAPITAL/PRIVATE EQUITY

In the course of putting together this report we have spoken to a few VC/private equity names that are actively investing in Russian fintech. This includes Vostok Emerging Finance, which is listed on the Stockholm Stock Exchange and owns stakes in Tinkoff and Revo, and Baring Vostok Capital Partners, which is also a shareholder in Tinkoff.



Irene Shvakman, BoD Chairman, Revo Technologies and Sorsdata

Irene Shvakman recently became the BoD chairman at Revo Technologies and Sorsdata, two leading Russian fintech companies founded in 2012.

Prior to joining Revo Technologies and Sorsdata, Shvakman was a senior partner at McKinsey & Company, where she led the financial institutions practice in Russia and Central and Eastern Europe.

Over her career, Shvakman has worked with leading financial institutions in the EMEA region, including banks, insurance companies and exchanges. Her work has included the launch of several greenfield banks in consumer finance and retail banking and has involved operational transformation, reorganization, M&A/alliances and efficiency improvement.

We caught up with Shvakman to discuss Revo Technologies and Sorsdata, and to hear her views on the fintech scene in Russia.

Please tell us a bit about your background in financial services and how you came to be involved with Revo Technologies and Sorsdata

I've dedicated most of my professional life to financial services, working in and advising large financial institutions in Russia, Central Europe and, more recently, also in Asia. Based in Russia since the nineties, I have seen the financial sector take shape and transform. Particularly amazing has been the speed of development of retail financial services.

My involvement with Revo and Sorsdata started as an angel investor. I saw tremendous opportunities for innovation by leveraging the newest technologies and data. I thought it would be possible to rethink how services are delivered and dramatically reduce costs.

So what can you tell us about Revo and Sorsdata? What is their business model?

Revo is a merchant services provider, specialized in delivering instant and paperless purchase finance solutions for leading on! and off!line retailers. Sorsdata focuses on generating unique marketing insights leveraging a wide variety of proprietary and third!party data. Sorsdata converts data insights into personalized marketing campaigns for merchants.

Both businesses have scaled quickly. In the past year, Revo has financed over a million and a half purchases across Russia. On a monthly basis, Sorsdata distributes hundreds of thousands of personalized promotional offers. The companies are growing very quickly, but staying focused on quality partners and consumers.

Describe your typical customers. Why are they attracted to using this service?

By now, we have partnerships with some forty national retailers in a variety of categories – from footwear to grocery to opticians. In the current economic environment, leading retailers are increasingly focused on maintaining an average basket and driving repeat customers. They appreciate our ability to deliver innovative solutions that bring measurable improvements in their business.

What is your main competition? Are you disrupting banks’ business or do you view this as tapping into a new niche?

Both companies deliver innovative services in the market which could not have been possible even a few years ago without the latest technology and data. Traditional institutions are generally not competing with us because these are very specialized segments of the market that require new capabilities and a much lower cost base to be profitable.

Tell us about your credit risk process. How has asset quality evolved?

We work with leading merchants who cater to mass!market consumers. Typically, our partners are in categories with low average tickets. We leverage traditional and new sources of data in our sanctioning process to make it easy and instant for the customer, while we can still maintain high portfolio quality. The market is evolving very quickly – new sources of data



are becoming available at a rapid clip, for example from mobile telephony, payment services, social networks and other sources. Our team is at the forefront of testing new data sources and integrating them into our decision engines. The variety and quality of data have improved as well, as our own data sets have gotten bigger and more refined. As a result, we see continued improvement in our portfolio quality over time.

How do you make use of new financial technologies in this business?

Our businesses are built with the latest mobile platforms and cloud!based SaaS solutions at their core. We are able to instantly access dozens of different sources of data available in the market to identify customers and filter information about them through our algorithms. These technologies have dramatically lowered the cost of delivering our services and have made most of our costs variable. More importantly, because all our products and processes are fully digitized, we are able to create a positive, instant, easy experience for customers, unlike what they are used to with traditional banks.

Do you think that household deleveraging is more or less done? Are we entering a new growth cycle for household lending?

I think the economy has not yet turned the corner. Consumers are feeling pinched and looking for value. Having said that, I hope that by now most of the consumer lending market's excesses have been worked through.

Last year, Revo and Sorsdata received some venture capital investment. From your experience, what are the challenges for fintech startups in Russia to obtain funding?

Last year was not ideal for raising capital. It coincided with tremendous economic volatility. By now, however, we see that there is more comfort with the economic outlook and

also growing familiarity with fintech among traditional investors. In general, in Russia there is limited experience with early!stage investing. The idea of taking minority stakes and backing founders is viewed by many with skepticism.

More broadly, how do you see the fintech landscape in Russia developing? Are there particular characteristics here that differ from other markets you are familiar with?

The same technologies that are enabling fintech emergence globally are also touching the sector in Russia. And Russia is a large market, which in and of itself could certainly support dozens of innovative fintech companies.

However, there are a number of market!specific factors that will influence how things will play out and whether a new segment of successful fintech companies will emerge. Structural differences between Russia and other markets are substantial. For example, in such areas as payments and wealth management, the fintech innovation we observe in other markets may not be easily transferrable. In online payments, low acquiring margins in Russia make it difficult for PSPs and mPOS players to reach profitability. When it comes to wealth management, the market for long!term savings is quite small and it is not clear that fintech models that focus here have a big enough market opportunity here.

There are other factors. Regulation in Russia in such aspects as customer identification, personal data protection, licensing, etc. can stand in the way of some innovative online offerings. There is a great opportunity for the regulator to spawn innovation and drive productivity in the sector by improving infrastructure and accelerating adoption of technology and automation. Lastly, private capital for early! and growth!stage is scarce, and this is likely to be a serious obstacle for many innovative companies.



Disclosure appendix

IMPORTANT US REGULATORY DISCLOSURES

Within the last 12 months, an affiliate of Sberbank CIB USA managed or co!managed a public offering of the securities of Tinkoff Credit Systems.

Within the last 12 months, an affiliate of Sberbank CIB USA has received compensation for investment banking services from Tinkoff Credit Systems.

An affiliate of Sberbank CIB USA makes a market in the securities of Moscow Exchange.

The research analysts, strategists, or research associates principally responsible for the preparation of this research report have received compensation based upon various factors, including quality of research, investor client feedback, stock picking, competitive factors, firm revenues and overallinvestment banking revenues.

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Investors should note that income from such securities or other investments, if any, may fluctuate and that the price or value of such securities and investments may rise or fall. Accordingly, investorsmay receive back less than was originally invested. Past performance is not necessarily a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur.Sberbank CIB accepts no liability whatsoever for any direct and indirect losses or damage or other consequences of any kind that may arise out of the partial or full usage of the materials from SberbankCIB Investment Research reviews. Investors should conduct their own evaluation of risks and should not rely solely on the information presented in Sberbank CIB Investment Research analytical reviews.Investors should obtain individual legal, tax, financial, accounting or other professional advice based on their particular circumstances. Any information relating to the tax status of financial instrumentsdiscussed herein is not intended to provide tax advice or to be used by anyone to provide tax advice.

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From time to time, Sberbank CIB or its affiliates or the principals or employees of Sberbank CIB or its affiliates may have or have had positions in the securities or other instruments referred to herein, ormay conduct or may have conducted market!making activities or otherwise act or have acted as principal in transactions in any of these securities or instruments or may provide or have providedinvestment banking or consulting services to or serve or have served as a director or a supervisory board member of a company referred to in this analytical review. Sberbank CIB's sales managers,traders, and other professionals may provide oral or written market commentary or trading strategies to Sberbank CIB's clients, as well as its proprietary trading desks where transactions are enteredinto at the expense and in the interest of Sberbank CIB, and such commentary may reflect opinions that are contrary to the opinions expressed in analytical reviews of Sberbank CIB Investment Research.Sberbank CIB's asset management, proprietary trading and investment banking business units may make investment decisions that are inconsistent with the recommendations or views expressed in thisanalytical review. Sberbank CIB maintains strict internal policies, which are designed to manage any actual or potential conflicts of interest.

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FOR RESIDENTS OF THE UNITED STATES. This analytical review is distributed in the United States by Sberbank CIB USA, Inc., a U.S. registered broker and dealer and a member of FINRA. This analyticalreview has been reviewed by research analysts who are neither employed by Sberbank CIB USA, Inc., nor registered or qualified as research analysts with FINRA, and are not subject to the rules ofFINRA. Sberbank CIB USA, Inc. accepts no responsibility for the contents hereof. In the United States this research report is available solely for distribution to major U.S. institutional investors, as definedin Rule 15a – 6 under the Securities Exchange Act 1934.

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