The economic impact of coronavirus remains hugely uncertain, but early signs are that it will have long-term consequences on the way we live, and is already pushing more and more aspects of daily life and economic activity online. This pattern is set to continue and, as people are adapting to working from home, they are increasingly using technology to manage daily life, personal finances included. This is likely to have a lasting impact and accelerate the structural shift to digitalisation across the financials sector.
As noted by Stripe, a digital payments platform: “Several years of offline-to-online migration are being compressed into several weeks”. We acknowledge visibility is low while we are currently in the eye of the storm, but nonetheless we have been assessing how the behavioural changes associated with the pandemic could affect the sector and have set out our key themes below.
The demise of cash
One impact of the crisis has been the reduction in the use of cash, prompted by restrictions on movement as well as concerns about the spread of infection. Link expects cash to fall to 10% of UK transactions by August, compared to 33% prior to the lockdown and 63% in 2008. The World Health Organisation says banknotes pose no more of a health risk than any other surface so while there is no evidence they have been a source of infection there is a public perception of risk. This has been compounded by government steps to quarantine banknotes, as seen in the US and South Korea; the Louvre in Paris has banned the use of cash; the state media in China has reported that banknotes from high risk infection areas such as hospitals and wet markets are being disinfected or destroyed. The risk of transmission from handling cash is not clear but studies have shown flu viruses can survive on banknotes for up to 17 days while a research team at NYU identified 3,000 different types of bacteria on dollar bills along with DNA from pets, other viruses and traces of drugs. As people adapt and shift to contactless and online payments, the pandemic appears to be accelerating the demise of cash which will have long-term consequences for financial services.
Payment companies benefiting from shift to online spending
The accelerated shift to online has benefited payment companies with 1Q20 operating trends highlighting the resilience of their business models. While not immune to the downturn, with particular weakness in the travel industry, payments companies like PayPal Holdings (PayPal) and Adyen (both owned by the Polar Capital Financial Opportunities Fund) have been beneficiaries of a rapid change in customer behaviour as consumers increasingly shift to e-commerce – PayPal averaged 250,000 net new active accounts every day in April, a growth rate of 135% year on year (y/y). Adyen, which reported a 38% y/y growth in 1Q20 processed volumes, saw weekly volume trends stabilise in April with a rise in online retail volumes, of 20-40% above the level reported in January, offsetting the decline in in-store volumes as customers adapted to lockdown measures. The acceleration in cash displacement can also be seen through the card networks, with Visa noting that overall contactless use in the US has risen by 150% y/y. The increased use of contactless payments to reduce transmission risk has been encouraged by public authorities and the industry has responded by expediting changes. UK Finance announced that the spending limit per transaction will be raised to £45 from £30 previously.
PayPal Net New Active Accounts Adyen Weekly Volume Trends
Source: Paypal (Q1 2020 results), 6 May 2020. Source: Adyen (Q1 2020 and COVID-19 trading update), 21 April 2020.
Digitalisation of banking sector to accelerate
Coronavirus will likely accelerate the ongoing process of digitalisation in the banking sector and be a huge advantage to those with the strongest digital capabilities – digital bank customers typically have a cost/income ratio of 34% compared to 54% for their traditional customers. As highlighted by DBS, those that have previously committed to digital banking will also be in a better position to manage efficiency. A recent survey by JD Power highlighted the pandemic has been a catalyst for a behavioural shift (36% of US retail banking customers surveyed plan to increase their use of online or mobile banking services post-coronavirus) with the crisis accelerating the trend of large US banks gaining digital customers at a faster pace than smaller and midsize banks.
Digital challenger banks look well placed for the new environment given their distribution capabilities and speed of innovation. However, recent data suggests these advantages have not translated into higher customer growth – the daily downloads of digital challenger bank apps have fallen year to date – or higher engagement – the monthly average users for European digital challenger banks is down 16% in the three months to 22 April compared to a fall of 9% for EU incumbent banks. Potentially, this reflects customer nervousness about untested models during a downturn while challenger bank growth ambitions may have to be scaled down to reflect a new venture capital funding environment. With the crisis emanating outside the financial sector and governments looking to use banks as a solution, through credit guarantee schemes, we believe this period offers an opportunity for incumbent banks to rehabilitate their image post the global financial crisis with the future winners likely to be those that are best able to leverage strong digital capabilities, including through partnerships with fintech providers.
Financial inclusion and public policy
The impact of coronavirus, including lower cash acceptance, reduction in remittances and lockdown restrictions, is expected to be particularly severe on lower income groups and those without bank accounts. This is likely to lead to a greater urgency in terms of public policy to drive digital payments and technology as a means of financial inclusion while fintechs can provide a valuable role in offering alternative payment methods. In Argentina, Ualá (a Tencent-backed fintech) has seen a 300% monthly rise in transactions on its digital bill payments service as customers have been unable to pay utility bills at the neighbourhood payment point. In India, the government has encouraged the use of contactless payments and UPI (a real-time mobile payments system), although there remain challenges for microlenders reliant on regular customer meetings. Ant Financial (Alibaba’s fintech affiliate) is using technology to offer access to insurance at low cost (there is a mere 4.5% insurance penetration rate in China) through a mutual aid insurance platform (Xiang Hu Bao now has 100 million members), and has recently included coronavirus as one of the critical illnesses covered, with its blockchain-based platform enabling a faster way to process claims and make payouts.
A catalyst for change
The pandemic has prompted a rapid change in behaviour which is set to hasten the reduction in the use of cash and involve a significantly higher level of digital engagement with financial services. These changes will be reinforced by public policy as governments look to encourage the use of digital financial services to tackle the crisis. We believe payment companies are a clear beneficiary of this structural change (and, at 27 May 2020, make up the large majority of the Polar Capital Financial Opportunities Fund’s fintech exposure of 16%) and the crisis is likely to widen the gap in terms of competitive positioning between the digital leaders and followers across financial services.