South Africa’s new banks nip at the heels of the big four

Change is under way in South Africa’s financial industry, forcing established lenders to adapt to competition from more nimble newcomers.

A handful of big corporations have long dominated South Africa’s business sector and much of its formal economy. Many of these were based in Johannesburg and to a lesser extent Cape Town, although that city was always strong in insurance, home to Old Mutual and others.

Today, Cape Town’s proliferation of San Francisco-style high-end coffee bars, zany haircuts and trendy restaurants suggests a tentative shift to a more innovative and open economy, or at least a desire for that.

The city has developed a reputation for tech-savvy entrepreneurialism, helped in part by its proximity to Stellenbosch University, and is both safer and more laidback than Johannesburg. In fact, Cape Town’s very success in attracting newcomers, particularly from Johannesburg, spurred its rapid growth and is one of the reasons for its recent water shortages, exacerbated by a prolonged drought.

Amazon developed an important part of its cloud-computing platform in Cape Town. Naspers, the Cape Town media company and former print publisher, is behind one of the best bets ever made on the internet thanks to its purchase in 2001 of a third of China’s Tencent for $32 million. In March this year, an accelerated bookbuild transaction for a 2% stake in Tencent yielded $10 billion for Naspers. South Africans will also remind you that SpaceX founder and Tesla chief executive Elon Musk was born in their country, even if Donald Trump has praised his rockets as American ingenuity.

Much of the local tech industry is about adapting existing technology to African realities in areas such as public health or education, infrastructure and security. It is increasingly the case in finance, too. Graduates from Stellenbosch’s well-regarded engineering faculty founded banking security firm Entersekt, for example.

Nedbank, one of the ‘big four’ lenders, was among Entersekt’s first clients, while Kenya’s Equity Bank and pan-African lender Ecobank are more recent customers. The service works on the premise that your phone – locked to Entersekt’s system either at a bank branch or remotely – is a better security device than a password, as you are more likely to know when someone steals it.

A stretched police force and widespread corruption provide the perfect breeding ground for security fintech, says Schalk Nolte, Entersekt’s chief executive. He gives the example of Sim-swap bank fraud – where fraudsters obtain a copy of someone’s Sim card and use that to access their bank accounts and other financial information – a form of fraud that has spread more recently to the US and UK.

“We are blessed to see these things first,” he says sardonically. South Africa’s developed financial system means “first-world banking with third-world problems”, he says.

Other local fintech firms that have expanded internationally include store rewards firm wiGroup, cryptocurrency wallet Luno, student loans firm Prodigy Finance and Jumo, which enables African lenders to determine creditworthiness using phone data.

Today, about 20% of South Africans do not have bank accounts, compared with about 50% in 2000. That’s good progress in the view of Kuben Naidoo, banks registrar and deputy governor at the South African Reserve Bank, who gives several reasons for the growth in financial inclusion: the rise of mobile phones and mobile banking; digitalization of national identification; the launch of bare-bones Mzansi accounts in 2003 by the big four banks to provide the poor with low-cost banking services; and the government’s distribution since 2012 of millions of pre-paid credit cards as a means to give out social grants.

Cash in circulation in South Africa, according to Naidoo, has fallen more rapidly than in developed countries, and is low by emerging-market standards, at 2.6% of GDP.

Nevertheless, South Africa has suffered from a lack of digitally innovative challenger banks. Fintech firms have generally had less luck in the business-to-client market, with the exception of certain niche firms such as Mama Money and Mukuru, which serve remittance routes, especially to Zimbabwe.

Over the last decade, east Africa has led the world in the development of mobile money, or payments by text message, mainly thanks to the popularity of M-Pesa, which was launched in 2007 by Vodafone and its Kenyan partner Safaricom.

Mobile money has been something of a flop elsewhere in Africa, notably in Nigeria and South Africa, despite intense efforts in South Africa to replicate M-Pesa’s success by both Vodafone and local rival MTN.

A common theory – and the one most sympathetic to the establishment – is that M-Pesa proved less successful in South Africa because the country’s financial infrastructure is more developed: with more cards and ATMs available, there is less demand for mobile money. Another view is that the Kenyan regulatory environment was more permissive. Other countries considered Safaricom’s new-found importance to Kenya’s financial system risky, and made it harder for mobile money firms to hold clients’ money, for example with limits on the amounts that can be transferred; however, Naidoo says his caps on mobile-money transactions and deposits are not unusually low.

But the sight of long queues at ATMs on pay day, even at no-frills Capitec Bank, suggests South Africa is not an idyll of digitally advanced inclusive banking.

Official figures show that banking penetration is deeper than in other African countries, but the true extent of financial exclusion is obscured because a large number of people carry out so few transactions, according to Gavin Krugel, who runs fintech education charity Digital Frontiers Institute in Cape Town. People tend to withdraw cash as soon as it is credited, mostly because of exorbitant bank fees, he says.

A report last year by the Boston Consulting Group showed South African bank fees are four times as high as in many developed markets, and high compared with countries such as India. Bank fees discouraged poorer consumers from leaving money in their accounts, the report showed.

The issue has also climbed up South Africa’s political agenda, with a parliamentary report in late 2017 referencing complaints, for example, from trade union Cosatu (part of the governing coalition) over “excessive bank charges”. The committee said fintech and digital banks could help reduce fees.

“South African bank charges are high by international standards,” confirms Naidoo.

Like others, Krugel believe high fees are largely down to the regulator’s understandable, but sometimes overbearing, concern for financial stability and consumer protection.

“Consumers are coerced into the incumbents,” Krugel says.

A self-regulatory framework under the Payments Association of South Africa (Pasa) does not allow formal barriers to competition but it does permit incumbents to design standards to their liking, he adds. Pasa authorizes the dominant domestic clearing house, BankservAfrica, in which each of the big four has a 23% stake, he notes.

Naidoo says that fees have declined during his tenure since 2013, and are converging with those in Europe, where fees have risen.

Aside from relaunched versions of existing banks, until last year South Africa had only registered one genuinely new bank since the late 1990s – Finbond Mutual Bank, in 2012. Bank concentration is similar to that in the UK, Australia or Canada, according to Naidoo, and the big four control almost 90% of assets. The number of banks dropped rapidly after a sovereign debt crisis in the middle of the 1980s, under apartheid, and again around the turn of the millennium, during the Asian financial crisis.

There is, Naidoo admits, a delicate balance between maintaining financial stability and boosting consumer choice.

“It is true that the highly concentrated nature of the sector has contributed to the pricing power of the banks; the relatively oligopolistic nature of the industry prevents competition from cutting prices,” he says. “It’s true that the policy framework preferred fewer banks that were well-capitalized and easier to regulate.”

Is this changing? In 2017 and until August 2018, the central bank registered four entirely new banks, TymeDigital, Discovery Bank, Ziphakamise (which has a cooperative banking licence) and Bank Zero, a new online mutual lender. In June, Young Women in Business Network (YWBN) also applied to convert from a cooperative financial institution to a mutual bank. Sarb has also awarded a provisional licence to an offshoot of the South African Post Office during this period.

Although the post office plans to use its physical network, Naidoo says these are all tech plays.

“The challenge of retail banking is the legacy infrastructure of the banks,” says Tyme’s chief executive, Sandile Shabalala. “We are building a digital bank through and through.”

It is similar to the trend in India, where former central bank governor, Raghuram Rajan, licensed an unprecedented slew of tech-orientated new payments firms and microfinance banks in the latter part of his tenure, which ended in 2016.

This can happen more easily now in South Africa, as financial software is cheaper and more readily available, while customers are more comfortable doing online banking.

“The cost of technology is lowering the barriers to entry,” says Naidoo. “That will continue to happen. We are moving to a more diversified banking sector.” 

Minimum capital requirements have also more than halved in real terms, he adds, as the nominal threshold has not changed since the late 1990s.

First National Bank (FNB) is the country’s biggest retail lender. Ryan Prozesky, FNB’s consumer core banking chief executive, says some of the complaints about high fees ignore how banks such as FNB segment their customers so that the new basic accounts cost much less than those designed for richer people.

Michael Jordaan, the founder of Bank Zero, should know if the fee grumblers have a point; after all, he was chief executive of FNB between 2003 and 2013. He says much of FNB’s gain in market share for retail banking, especially towards the end of his tenure, was due to relative technological advance: launching an app before others, for example, selling discounted smart devices and introducing international payments via PayPal (currency controls meant you had to have an FNB account).

It was also thanks to adjusting fees ahead of the competition, Jordaan says, at a time when it cost more to bank online than at a branch, and at the same time focusing less on customers who just had loans, which in turn cut capital consumption, to further boost returns.

That said, Bank Zero, which Naidoo licensed in January and Jordaan plans to launch early next year, is a direct response to the idea that South African bank fees are a rip-off, including for SME customers.

A bank with zero fees “is a big deal in South Africa”, says Jordaan.

Even in shorts and flip-flops, sitting opposite a sweating and suit-garbed Euromoney journalist earlier this year in the Cape summer, Jordaan still manages to exude the authority and impatience of a Johannesburg corporate executive.

“I love banking,” he says, sipping a local white wine. “It was inevitable that I would return.”

But after he left FNB in 2014 and returned to his rural Cape homelands where he owned a vineyard, Jordaan had time to reflect. He concluded that most established retail banks’ costs, including technology and IT consultants, are unnecessary.

“If you had to reshape banking from today, you wouldn’t need 600 branches, but the best possible mobile experience,” he argues.

According to Jordaan, open-source software allows Bank Zero to build “a modern, scalable bank” with almost no costs and no fees. He envisages no more than 15 employees, and says 95% of its tech stack – software products and programming languages – was free. He hopes to rely solely on word of mouth and social media, instead of paid-for marketing.

Lower costs should mean good profits, despite lower revenues: the latter will come entirely from treasury management of retail deposits and from the card-interchange fees that merchants pay.

“These two income streams are more than adequate,” he says.

Discovery Bank seems likely to focus on higher-income groups, using its brand and network as a life and medical insurer. Discovery also has a reputation for innovation; it offers generous discounts on gym membership and on holiday spending, recognizing that healthier customers will require smaller payouts in the long term.

Meanwhile, Tyme – like Postbank – is targeting a much wider customer base, particularly those put off by high bank charges. It grew from a firm, ‘Take your money everywhere’ (hence Tyme), which started out by providing core banking systems. Initially, it worked on MTN’s mobile money project in 2012, before being sold in 2015 to Commonwealth Bank of Australia as something of a test site for Asia.

“We’re not targeting the unbanked – the majority will have a bank – but the underserved market, those that have an account but are not using the full functionality of the bank,” says Shabalala. “The opportunity is in financial inclusion and education, in providing banking that’s affordable, with much broader access to banking and creating transparency in products and costs.”

Tyme has already launched a domestic remittance service, using kiosks with identification gadgets at 700 Pick n Pay supermarket stores, so that customers can use mobile vouchers and the stores’ tills to send and receive money.

FNB has a similar and bigger e-wallet scheme, using its own network and Spar supermarkets. But Tyme’s 320,000-strong money-transfer clientele is a good base for such a young firm, says Shabalala. Early in 2018, it was already replacing these kiosks with new ones that can sign up bank clients, with the tills then able to process deposits and withdrawals.

“At Tyme, there are no bricks and mortar, and some of those efficiencies will be passed on to the customer,” says Shabalala.

One of the bank’s first projects will be a financial education programme, before it moves onto savings and then unsecured lending.

Tyme, like Discovery and Postbank, shows how these new banks must work with the financial establishment if they are to have an impact. A big established bank, albeit a foreign one, was the initial owner of Tyme. Then African Rainbow Minerals – chaired by South Africa’s richest man, Patrice Motsepe – bought a minority 10% stake last year, and is now seeking regulatory approval for an agreement with Commonwealth to buy the remainder. ARC will help with marketing and will put Tyme kiosks in mines and other locations.

Bank Zero can rely less on institutional support, largely because it is licensed as a mutual bank, which Jordaan says requires less capital and investment in systems than a full commercial licence, even if that also means a more restricted product offering. Chief executive and co-founder of Bank Zero, Yatin Narsai, was head of retail at FNB.

Jordaan says Bank Zero is not part of a post-FNB master plan between him and Narsai, who left with a three-year non-compete agreement. Still, he says he has an emotional connection to FNB and with the friends and mentors he found there.

One way or another, the big four will still cast a long shadow in South Africa. Small businesses and startups with high ideals about inclusiveness tend to graduate to the easier option of serving the big firms, says one experienced member of Cape Town’s fintech industry.

South African economic policy has often revolved around big state-owned corporations. But there is also something of a tradition, not always chosen, of local development and manufacturing. This became more of a necessity as the international isolation of apartheid wore on, and businesses began to develop in parallel to their peers in developed markets.

Nowadays, both old and new firms often find expansion abroad, rather than at home, more appealing because of the woeful state of the South African economy, even though the very unattractiveness of the domestic economy deters foreign investment and affords a degree of protection to local producers.

For smaller firms, confronting the oligopoly head-on might be hard. Even so, they enjoy some similar international protection, too, as US or European suppliers are less likely to bother trying to navigate such a small and idiosyncratic economy, notes a local fintech consultant.

Katlego Maphai’s firm Yoco could be an example, given its similarity to point-of-sale payment firms such as Square in the US and Sweden’s iZettle, both of which have concentrated on bigger, developed markets.

The way the former consultant sees it, as is the case elsewhere in the world, established firms in South Africa are now more open to collaborating with fintech startups through investment and partnerships, as well as incubators and the like.

“Before, banks were more defensive; now there’s more cooperation,” Maphai says.

A partnership with Standard Bank was crucial to the success of popular local mobile app SnapScan, for example. South Africa’s big banks are also the basis for Entersekt’s success, giving it around 80% of the local retail market (FNB, characteristically, created its own equivalent).

Maphai, as the founder of an independent firm, has had to make sure the establishment is on his side.

“The whole thing with fintechs is that [people fear] they are bringing risks into the system, that we’re playing it loose,” he says. Yoco does real-time monitoring of transactions that can quickly flag unusual behaviour, including the volume and location of transactions, to detect fraud more effectively.

He adds: “We’re demonstrating the opposite: that with tech and data we can catch things as they happen and reduce risks,” he says.

Travelling around South Africa earlier this year, Euromoney came across a farmer who had made a packet from selling to distributors in informal township areas, where maize (known as mealie) is the food staple. The problem was that payments were all in cash – the equivalent of hundreds of thousands of dollars.

Reducing the use of cash in the economy, including in informal areas, could do much to oil the cogs of growth, especially given the high level of crime in South Africa.

“The key lies with the merchant,” says Andre de Wet, formerly head of business development at PayU, part of Naspers. “If you can find a payment method [the merchant] can offer, everyone will start using it.”

He says this is why mobile money flopped here: because the township spaza – informal convenience stores – did not use it, unlike their Kenyan equivalents.

One firm that thinks it might have an answer is Yoco, started by former tech and telecoms consultant Katlego Maphai. It distributes and operates low-cost mobile card readers, in a manner similar to Square in the US and particularly Sweden’s iZettle, which uses the same UK manufacturer of chip-and-pin devices, Miura Systems.

Yoco has gained more than 27,000 merchants and is growing at a rate of about 1,500 a month.

Its card readers are particularly relevant to South Africa given the high level of card ownership but very low level of card acceptance among merchants, particularly in poorer areas.

Only about 6% of South African businesses accept cards, says Maphai: “Consumers have cards but not enough places to use them. It’s our job to close that loop.”

Three quarters of Yoco’s merchants did not previously accept cards. Supplying the machines to micro-businesses is still not economically viable, he says, but it will be once Yoco has greater economies of scale, and as the pin-pad and screen disappear from its devices, lowering their cost. It has also partnered with a large foreign bank for a pilot scheme that uses the merchants’ payments data to do targeted working capital loans – again, following iZettle.

As in other areas of South African retail banking, Maphai says monthly fees and the need to prove a clean trading history were barriers to growth in card payments. Yoco gets around this by aggregation, so the banks’ main risk and counterparty is Yoco, rather than thousands of tiny merchants.

Another problem at the banks, Maphai says, is that they can be locked into long-term procurement contracts with the more expensive, mainstream card-reader manufacturers, such as Ingenico and Verifone.

Yoco says its fee per transaction, 2.95%, is often lower than more established competitors, which also (unlike Yoco) tend to charge monthly fees and a much larger initial fee for the device.

“If we’re not building out and bringing new businesses into the acceptance space, we’re not being market makers,” Maphai says. “If you’re just serving the large and mid-sized businesses, it’s safe and predictable, but you’re just joining the queue.”