Indonesia's online banking race

Indonesia's online banking race

The following article by Fabrice Desmarescaux is based on a
presentation in a seminar on e-finance. It was held here on June
5 by, among others, McKinsey & Company's Financial Institutions
Group, where the writer is a senior consultant.

JAKARTA: Online banking -- a trend that is sweeping the world
-- has been notably slow to take off in Indonesia. Only one major
domestic bank currently offers a significant online banking
service, and the service is used by only a handful of retail
customers. But despite this slow start, there is ample reason to
believe that online banking here is poised for rapid growth.

Banks have been slow to offer online services for a number of
reasons. Most importantly, the demands of recapitalization and
restructuring have posed major distractions from new initiatives
such as on-line banking. Only a few small, well-managed banks are
healthy enough to make the development of online banking services
a priority. Yet most of these banks are too small to achieve the
scale needed to make online banking profitable.

A second reason for Indonesia's slow e-banking start is that
the potential customer base has been limited. With less than one
million Indonesians online, there has been scant incentive for
Indonesian banks to move into e-banking -- or for international
e-banks to move into Indonesia. In the relatively near future,
however, this is likely to change.

Using the new technology of wireless application protocol
(WAP), Indonesian banks will soon be able to deliver Internet
services via cellular phones, rather than through personal
computers (PCs).

Although WAP services are still rudimentary in Indonesia, they
are improving rapidly and broadband wireless access appears to be
just around the corner.

Banks will soon be able to tap a sizable and affluent market
via mobile banking: 2.5 million Indonesians own mobile phones --
roughly three times the number that currently access the Internet
via PCs. The advent of "mobile banking" will likely touch off a
heated race to dominate online banking services.

But while online banking will open new opportunities, it can
also pose threats for those banks that are slow to react. The
cost of erecting an online bank is falling precipitously, such
that more and more international banks are offering online
services.

Their services are becoming increasingly sophisticated, often
bundling banking instruments with stock trading, insurance advice
or shopping. Since transactions are conducted entirely in
cyberspace, international banks can compete with local banks
without even establishing a physical presence or legal status in
Indonesia.

For these reasons, Indonesian banks will need to move quickly
lest their customers flee to cyberspace competitors. The threat
is real: online services are increasingly in demand by banks'
most valuable customers -- those that generate the highest fees.

In Indonesia, banks typically earn over half their income (and
80 percent or more of their profit) from the top 10 percent of
their customers. Losing that high-value market segment would be
devastating.

These issues are well understood by Indonesian banks, many of
which will soon be moving into on-line banking. Once this race
starts, it will be a heated battle for the most profitable
customers.

The bank that attracts and retains these customers will
trigger a "virtuous loop": the profits from online banking can be
reinvested to further enhance online services, thereby attracting
more high-value customers, and so on.

Ultimately, this can lead to a "winner-takes-all" scenario in
which one or two large banks dominate online banking. Others will
be forced to fight among themselves for limited market shares --
or simply forego online banking altogether -- while still bearing
the huge cost of branch distribution.

The "winner takes all" scenario, which is seen in a host of e-
commerce sectors, seems particularly likely to transpire in
Indonesia. Unlike in the United States, where top customers are
scattered across different regions and each region has its own
leading bank, Indonesia's top customers are highly concentrated
in Jakarta. This makes it relatively easy for a single bank to
reach the entire group.

Who, then, is likely to win the upcoming battle in online
banking: traditional "bricks and mortar" banks or start-up
"Internet-only" banks?

The experience of the US shows that, despite the prevailing
"Web religion", traditional banks can be formidable competitors:
Internet-only banks stormed onto the scene in 1998, but
traditional "incumbents" were quick to respond.

By moving much of their customer base online, incumbents have
secured and, thus far, retained the largest share of the U.S.
online banking market.

Will Indonesia be any different? It seems unlikely that
Internet-only banks will be a major force here: given the general
lack of familiarity with the Internet, Indonesian customers are
probably not ready to entrust their savings to full cyber-banks.

But there are more significant threats from major
international banks, such as Citibank and Hong Kong Shanghai
Banking Corp., which are already well-known in Indonesia.

Many international banks are already offering online services
for offshore accounts, and they are well-positioned to offer
their services in Indonesia when they feel the time is ripe.

But local banks certainly have abilities to compete. For
instance, they can leverage their knowledge of local customers to
develop services that cater specifically to local needs, such as
language factors, cultural preferences, or bandwidth
restrictions.

They can also leverage their extensive branch networks as
channels for spreading awareness of online banking -- many
subscribers will need to be "coaxed" online with demonstrations
and exhibits.

Finally, relative to foreign banks, Indonesian banks are far
better positioned to serve small to medium-scaled businesses, and
this could become a profitable venue for expanding online banking
into a vast array of e-commerce activities.

In sum, the final winners are likely to be those that move
swiftly, attract the right customers and consistently deliver
top-quality services.

As in most online ventures, the winners will combine near-term
implementation skills with longer-term vision in a rapidly
changing business environment. These winners stand to dominate a
highly strategic and profitable sector.