BNM is expected to introduce a sector friendly digital banking framework. Even if it turns out to be unfavourable, we reckon digital banks are not major threats as traditional financiers have been actively embarking on digital transformation projects to shift away from outdated business paradigms. However, catalysts to spur strong sector-wide growth (in the near to medium term) remains missing. Hence, current sector valuation is fair since it is discounted at -2SD to its 5-year mean P/B. Those that favour exposure to this sector have to be selective. Our preferred pick is Maybank (TP: RM9.50). Other BUYs include RHB (TP: RM6.45), Alliance (TP: RM3.40), and BIMB (TP: RM5.00).

The rise of digital banking. Apart from product innovation, the rapid technological advancement over the past decade has created new business opportunities for the services sector. Sadly, some traditional industries were blindsided by their sudden burst onto the scene and left flabbergasted, without proper tools to fight back (e.g. taxi vs Grab). Now with digital banks lurking, what would be the fate of archaic financiers?

How will BNM’s digital banking framework pan out? We expect it to draw similarity to those of our neighbouring countries, especially Singapore. More importantly, we see BNM not championing business models that engage in value-destructive rivalry to gain market share; the objective will be to serve the underserved segments. Also, we think BNM would want to retain the anchoring position of local banks, considering that government linked investment companies have a relatively large stake in them.

How disruptive would digital banks be? Although BNM is expected to support a benign competitive environment, we take no chances and performed a study on how traditional financiers fared in China and Korea - before and after the advent of digital banks. In general, we find that loans and deposits growth trajectory remained robust while NIM held steady, putting aside the impact of any monetary policy actions. With these discoveries, it seems like digital banks are not major threats and they can co exist quite harmoniously with their traditional counterparts.

How banks are coping with digitalization? They have been actively embarking on new digital transformation projects to shift away from outdated business paradigms - key focus revolved on improving customer experience. Although most local banks have already equipped themselves with front-end digital apps, we noticed these are not being harnessed to their full potential. Besides, we feel that local banks are not exploring enough on big data, artificial intelligence, and machine learning. However, reliable and effective cyber resilience mechanisms were adequately put in place.

Bigger banks more gung ho. We find that Maybank and CIMB are leading the pack in the digital space; they have more budget capacity than others (given their bigger balance sheet to spend) and are aware that successful investment bets can lead to extraction of meaningful positive operating leverage. As for smaller banks (like Affin and BIMB), they will need to up the technology ante to stay relevant, given the new generation of banking customers are more savvy and demanding.

Retain NEUTRAL. With banks increasingly turning digital, perhaps we should analyse them like a tech company (using P/E) at point of inflection. That said, majority of their profits now are still derived from non-digital channels and accordingly, do not warrant a switch in valuation yet. Also, catalysts to spur strong sector-wide growth (in the near to medium term) remained missing. Hence, current sector valuation is fair, discounted at -2SD to its 5-year mean P/B. Our preferred pick is Maybank (TP: RM9.50). Other BUYs include RHB (TP: RM6.45), Alliance (TP: RM3.40), and BIMB (TP: RM5.00).

Source: Hong Leong Investment Bank Research - 30 Oct 2019