Lower profitability ahead for Thailand banking sector amid economic headwinds, maturing market structure and elusive payoff of digital investments
Commercial banks in Thailand are facing deteriorating market conditions, including intensifying competition, commoditization of services, shrinking of some fee revenues, and potentially increasing Non-Performing Loans (NPL). A lot of headwind is expected in the next five years, putting the Thai banking sector's profitability metrics under duress. Declining profitability will likely influence senior management's decision to undergo further cost structure adjustment in the banking sector.
Our study provides a breakdown of the unfolding market headwinds and suggests avenues to bank leaders to protect their Return on Equity (ROE) from erosion. Thai commercial banks will be hard-pressed to achieve the previous years' average ROE of 8%. Instead, the profitability of the entire banking sector is at risk of falling to an average ROE value of around 6.6% over the next three years.
As the Thai banking sector transitions towards a more mature market stage, banks are susceptible to common ailments which often characterize such a phase, such as margin compression, slower annual revenue growth, as well as rising personnel, regulatory and compliance costs. At a time when the macroeconomic outlook is less buoyant, the ongoing digitalization of banks' business models cannot deliver revenue growth or cost reduction fast and strong enough to compensate for revenue erosion and margin compression.
In the coming years, banks are less at risk of losing out to new digital disruptors and entrants than they are of eroding their revenues and profit due to insufficient adjustments in their operational model and cost structure. Drawing a parallel to mature economies, the sector's bloated cost structure represents a risk amidst a new environment of slower growth and changing consumer preferences.
Thai banks decisively need to rely on proven short-term cost containment initiatives to weather the next three to five years while they rebalance their portfolio of digital investments. Ultimately, our study estimates that between THB 100 billion (~USD 3.3 billion) and THB 180 billions (~USD 5.7-6.0 billion) of cost saving would be needed in the next five year to fight ROE erosion in the Thai banking sector.
Decoding the slowdown of recent years
For a majority of the past two decades, Thailand's economy has enjoyed a steady recovery from the 1997 Asian Financial Crisis and even went through a period marked by a high growth rate in commercial banks' assets of 8.0% per year up until 2013. More recently, asset growth has slowed, averaging a weak 3.7% annually between 2013 and 2019. Around this period, many Thai commercial banks launched broad-based transformation programs to sustain top-line growth and increase efficiency.
There has since been an explosion of digital transformation programs – spanning from robo-advisor pilot initiatives, customer service chatbots, revamped mobile banking experience, IT cloud adoption, to online credit assessment for lending. The combination of these digital programs has put a significant investment burden on banks that will last several years before projected dividends materialize.
In practice, adjustment to cost structures are needed in the short term as banks are in the middle of a difficult journey. This momentum can be amended but should not be stopped entirely. Banks still have to go through what we call the "Valley of No Return" until the digital dividend pays off. This will most likely be a longer-than-expected walk.
Tightening the ship to mitigate banking profitability decline in Thailand
To prevent deteriorating profitability across the banking sector, our study estimates that Thai banks need to produce approximately THB 100 billion (~USD 3.3 billion) in cost savings from now until 2024. In a worst-case scenario, the required cost saving rises to around THB 170-180 billion (~USD 5.7-6.0 billion).
Three complementary and well-proven approaches need to be considered by banks in performing their cost adjustment. The first method, Accelerated
Zero-based Budgeting, deconstructs existing activities and ways of working, and thereafter systematically challenges the necessity of each line item. The program historically brings an average of 12% to 15% in net cost savings.
The second approach that has been proposed targets banks' large purchasing spend, by cultivating Procurement Excellence best practices in spend categories management, organization structure, as well as tools and processes. This systematic program traditionally yielded anywhere between 8% to 12% in savings, with less mature companies producing more savings if drastic changes in practices were introduced.
A third approach, Frugal IT, encourages banks to challenge the value of every IT and digital investment item with a very granular approach. In assessing trade-offs for value, trimming not absolutely necessary run-the-bank proposed developments, and looking for pragmatic toned-down upgrades banks have historically enjoyed 10% to 20% of savings as a result.
As the Thai banking sector transitions from fast-growing to a mature and sophisticated sector, banking players are confronted with a changing competitive landscape. A lot of work will be needed for the banks to transition and adjust to the new structural realities of the market. At this stage, proven cost containment measures can help them bolster their profitability and provide leeway for the further strategic investments required. Taking proactive steps now will allow banks to be in a better position to benefit from the next economic uptick, and enjoy the positive mid-to-long term growth perspective of the sector in the region.
Thailand Banking Market: How to bridge the profitability gap
Strategy consultancy Roland Berger research on Thailand Banking Market and the profitability gap that commercial banks must mitigate through cost restructuring while waiting for dividends from digital transformation projects.