Can Australian banks fend off the challenge from digital natives?

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Australia's banks are in for quite a fight if Morgan Stanley's new report is accurate. The U.S. investment bank estimates in its newest Australia In Transition report that digital wallets could capture US$22 billion of revenue that in a less digitized world would have gone to the banks. Morgan Stanley's advice for the banks is blunt: Up your digital game before it's too late.

It's not as if Australian banks don't have digital platforms. They've long had Web-based service, and increasingly customers can access their accounts via mobile phone. Of course, Banks want customers to use their apps rather than third-party wallets as the banks earn a higher interchange commission that way.

But customers may prefer the digitally native platforms that allow users to link multiple bank accounts and credit cards to a single wallet. PayPal has been offering those services for more than two decades. Now mobile-first platforms like Google Pay, Apple Pay, and Samsung Pay offer the same type of service but tailored for a smartphone instead of a desktop computer.

At present, Australian customers are using both types of platforms in roughly equal number. Data from Roy Morgan cited by The Australian Financial Review found just a 1% point difference between the percentage of Australian using digital payments services offered by banks own mobile apps (5.8%) and big tech firms (6.8%).

"We think increasingly customers are likely to base their decision [on who to bank with] on the features in the app, and a lot of those features are payments-related,” Richard Wiles, a banking analyst at Morgan Stanley, wrote in the report.

Among the Big Four, CBA has the biggest tech budget and best banking app, while ANZ comes in last, Morgan Stanley says. CNB plans to spend US$5 billion on technology over the next five years to beef up its digital capabilities.

It's no surprise that Australia's traditional banks are struggling to develop digital platforms that are competitive with big tech. Cumbersome legacy IT systems are part of the problem. It's much easier to launch digital banking services when you're digitally native and don't have to build on top of something created in the pre-internet age.

One possibility that each of Australia's big four banks has considered is establishing a new digitally native bank brand aimed at young consumers who bank with their phones. Most of those plans have yet to bear fruit, because of investment restrictions and bureaucratic hurdles, analysts say. National Australia's UBank is the exception.

Meanwhile challenger banks are arriving in swaths to the Australian market, some with restricted banking licenses and others with full retail banking licenses. As of June, besides U Bank there are Archa, Bene, Goldfields Money, iSignThis, Judo Bank, Pelikin, QPay, Revolut, Tyro, Up, Volt Bank and Xinja.

In our view, the path of least resistance and likely the way forward for Australian banks would be partnering with fintechs. If you can't beat 'em, join 'em, right? Traditional banks have industry experience, large customer bases and are familiar with regulations. Fintechs have new technology and business models that can serve a new generation of customers. The partnership between Bendigo Bank and Up well illustrates this concept. Because they are working together, Up doesn't need to apply for a banking license.

As more neo-banks enter the Australian market, the Big Four need to think about how to most adroitly meet the challenges they pose. Cooperation with newcomers is an option worth pursuing.