Cut barriers to entry for new players in banking

Trudi Makhaya

15 March 2016

IN THE next few years, the South African banking sector will see shifts in ownership due to developments at Barclays, Old Mutual and the reconstitution of African Bank. These have been touted as opportunities to bring new players into banking. But what about entrants who want to pursue their own business models as competitors to the incumbents?

Last year, through the Centre for Competition, Regulation and Economic Development (CCRED), Nicholas Nhudu, Nomvuyo Gama and I co-authored a case study on the experience of Capitec Bank as an entrant to the retail banking industry. The Competition Commission held a market inquiry into retail banking and, in 2008, issued recommendations to make banking more transparent and competitive. Some, but not all, of these recommendations have been implemented by government and industry.

New entrants would alter competitive dynamics in banking, but this is a sector characterised by high barriers to entry. Some of these are due to the structure of the industry, others are due to regulation and the behaviour of banks.

Although consumers like to gripe about their banks, consumer behaviour is an important barrier to entry in banking. Consumers across the world do not switch their banks very often, especially not from long-established brands to emerging ones. Part of it is inertia, but lack of information and onerous processes are also to blame. This implies high outlays on brand development by entrants, which cannot be recovered if the venture fails. Another sunk cost is start-up capital to acquire a licence and build systems.

Banks cannot operate as silos — their cards have to work at all ATMs and other banks should be able to deposit salaries into them and deduct payments. Hence a new bank has to navigate SA’s sophisticated payments system. This depends on the co-operation of the other banks. In the past, there have been instances where banks have been accused of frustrating each other’s efforts to integrate new products and innovations.

Capitec’s success was by no means assured, with the bank coming to life soon after the "small banks crisis" of the early 2000s that dented consumer and investor confidence in small or new banks. Unsurprisingly, having a significant backer, PSG, made a huge difference to Capitec’s prospects. For the greater part of its infant years, Capitec was self-funded and significant portions of profits were retained into the entity. Although the bank took a conservative approach towards debt funding, it also acknowledges that this was partly due to the inaccessibility of debt markets by small companies.

Capitec’s innovative, technology-optimising business model changed banking for the mass market. Its entry expanded the market by attracting the previously unbanked. It also improved service and offered lower service prices to what Capitec executives call the "badly banked". The lower prices are not enjoyed only by the bank’s customers. Other banks have reduced their prices in the mass market segment, and have introduced innovations that mirror those introduced by Capitec.

Technology and business-model innovations have expanded the range of institutions that can offer transactional banking services beyond traditional bricks and mortar banks. Proposals for a tiered banking licence regime that would enable less onerous capital requirements for institutions taking on limited deposits need to be revived. The study also argues for enhancements to the consumer-switching process and for payments-system regulation that facilitates and encourages faster adoption of innovation. If these measures to ease entry are not pursued, entry will remain elusive or be so onerous as to mirror historical patterns of ownership in the economy.

CCRED will hold a public seminar on the retail banking case study on Thursday at its Rosebank offices.

• Makhaya is CEO of Makhaya Advisory

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