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.