S&P Global Ratings thinks that the Swiss retail banking sector is an unlikely candidate for major tech disruption over the next few years. This reflects the population's cultural conservatism that is still slanted toward personal advisory for important financial decisions, such as mortgage financing, pension plans, and wealth management. We also believe the country's small market size outside the European Economic Area (EEA), with only a few foreign banks having a market share, currently helps to ward off a more pronounced entry of international fintech or big tech companies into more areas of the traditional banking value chain. Effective IT operations collaboration between domestic banks remains minimal and Swiss federalism complicates common projects even between cantonal banks, which could boost material cost savings. Domestic banks have already digitalized a number of standard banking services but overall pursue a "fast-follower" approach in developing digital services. This reflects a lack of customer demand for pure online products and the niche role of national and international challenger banks in Swiss retail banking.

In our view, domestic banks have access to state-of-the-art technology and do not lag behind new players. Numerous market-led initiatives to build open banking standards exist but new market players face the challenge of the absence of a binding regulatory framework, which is likely to support domestic banks in defending their market shares in the short term. However, in the longer term, banks could lose the pace of digital innovation versus the big tech companies if they were to enter the Swiss banking sector more widely. While the Swiss Financial Market Supervisory Authority (FINMA) encourages innovation through companies' use of a regulatory-lite fintech license or sandbox approach, we expect this to mainly support the development of payment or crowdlending services. However, we do not expect it to disrupt banks' mortgage finance operations, which comprise their core revenue source in retail banking.

We illustrate our current view of disruption risk in our four-factor analysis of a banking system's technology, regulation, industry, and preferences (TRIP). We do not assign an average or overall disruption risk score because we believe that a higher score in one category will not necessarily offset a lower scoring elsewhere (see chart 1). We consider that the current structure of Switzerland's relatively ringfenced industry poses low to moderate tech disruption risks.

Chart 1

Industry Disruption Risk | Low

Domestic banks largely own the Swiss banking market with foreign controlled banks only playing a niche role (mainly within retail banking). The Swiss retail banking sector is competitive, fairly saturated, and dominated by a few banking groups (see chart 2). The sector is dominated by UBS and Credit Suisse, the 24 cantonal banks operating predominately in their home cantons, and Raiffeisen Group, comprising 229 cooperative banks.

Besides UBS and Credit Suisse that have leading global wealth management franchises and a few larger private banks with international presence, most Swiss banks have an exclusively domestic focus, with high exposure to the mortgage and small to midsize enterprise (SME) financing segment. Consumer financing has a rather limited presence in most Swiss banks' portfolios, with some banks even offering the product under a separate brand, reflecting the bad reputation attributed to this product by the Swiss population. State-owned PostFinance--the banking arm of the Swiss post group--also counts as one of Switzerland's largest retail banks but remains prohibited from lending activities according to Swiss postal law. It still provides two-thirds of all payment transactions in Switzerland, reflecting its public mandate to provide essential banking services under Swiss postal law that also requires a dense branch network.

These banking groups account for more than 85% of market shares in customer deposits. In our view, the lack of economies of scale in retail banking makes Switzerland a less attractive target for international competitors. We consider the relatively small customer base of only about nine million inhabitants, high labor and administrative costs with four official languages, and different regulatory framework (to the rest of the EU), as the highest barriers to entry for foreign banks into the Swiss retail market. We consider competition between domestic players as material, but overall competitiveness is lower than in neighboring markets, such as Germany and Austria.

Mortgage loans dominate most customer portfolios, accounting for the largest earnings' share from domestic operations. Low interest rates and a reliance on deposit funding constrain profitability, however, some of this was previously absorbed through a system-wide lifting of asset margins on retail products, which also reflects the lower competition from foreign players. The high importance of the domestic mortgage financing market makes it an attractive target for digital platforms to gain market shares by offering price transparency and to develop lean processes for customers.

Broker portals such as homegate have increasing transaction volumes. However, with a market penetration of below 5%, we consider competition to banks from online mortgage platforms as being manageable. This is reflecting most Swiss customers' continued preference for personal advisory for first financings and banks' early response to refinancing to mitigate disruption. Still, the development of such platforms could constrain banks' earnings in the long term.

Retail market leaders cantonal banks--reporting retail banking market shares of up to 50% in their home cantons--have the most to lose, in our view. In response, individual banks have already built their own online platforms, but now face the risk of cannibalizing their own local franchises.

We calculate an aggregated cost efficiency ratio for Swiss banks of about 66% based on Swiss National Bank (SNB) data, which rank them in the European midfield (see chart 2). Cantonal banks predominately report efficiency ratios of near 50%. We see above average cost-income ratios at UBS and Credit Suisse, but these ratios are largely due to these players' (international) wealth management business characterized by low efficiency ratios but sound risk-adjusted returns and effective capital utilization.

Chart 2

The fifth largest bank, PostFinance, has a weak efficiency ratio of above 80%. This reflects its high reliance on income from fixed income securities, which is detrimental in a lower-for-longer interest rate environment. We estimate that the consolidated cost-efficiency ratio from domestic banking operations is only about 60%. This still means that cost efficiency remains clearly behind European "best-in-class" banks in the Nordics, while significantly outperforming banks in other jurisdictions such as Germany. Swiss banks are seeking to reduce dependency on interest income by increasing fee income, particularly from investment advisory-related activities. Cost management measures such as branch closures are also to offset ongoing margin pressures, which also reflects increasing customer demand toward digital channels. We consider the reduction of run-the-bank costs as critical to offset margin pressure in retail banking, and for banks to remain prepared for the potential entry of digital banks or big techs into more parts of the retail banking value chain.

Effective collaboration between banks remains minimal, often even within the same sector. For instance, most cantonal banks operate fully independently, run their own IT centers and product factories, and even increasingly compete in mortgage financing in regions outside of their home cantons. We think intensified cooperation, or even mergers between cantonal banks, could result in material cost savings. However, we view this as unlikely predominately because cantonal owners want to prevent losing control over a bank after being merged into a larger bank. Collaborations in Switzerland are limited to, for instance, SIX Group that runs the Swiss financial market infrastructure and to two central mortgage institutions (Pfandbriefzentralen) that enable the issuance of covered bonds backed by residential mortgages pooled by member institutions.

The most prominent digital collaboration is mobile payment service TWINT, with 1.7 million registered users. The service is similar to established mobile payment solutions 'Vipps' in Norway or 'Swish' in Sweden. Launched by numerous domestic banks (including the five largest ones) the objective was to become Switzerland's leading digital wallet and to fend off the rise of global mobile payment providers ApplePay or GooglePay. The large international tech companies had a difficult start in the Swiss mobile payment market, with for instance, Apple Pay being only initially compatible with a few credit cards.

Although near-term prospects look promising, TWINT could find it challenging to defend its market position against global provides in the long term. Apple's iPhone remains the most popular phone in Switzerland, especially with younger people who appear to use more mobile payment solutions. In the long term, we expect a shift toward global providers given that Apple customers have to have strong brand loyalty and TWINT, which also allows the inclusion of popular customer loyalty cards, is not yet ready for payments outside Switzerland. It plans to join the European Mobile Payment Systems Association (EMPSA), but with access to 25 million clients, it only covers a small part of the European market. The presence of non-payment services by big techs remains marginal in Switzerland. However, they generally remain ready to attack more areas of banks' value chains. Similar to most European countries, we believe that big techs will focus on cooperation with domestic banks in areas such as lending and asset management or in niche markets closer to their supply chain, and do not plan to become fully-fledged banks.

The limited market size with high barriers to entry also explains the limited presence of international fintechs or challenger banks in Switzerland. For instance, German start-up bank N26 entered the Swiss market as one of the last European countries (see table 1). It only provides euro accounts targeting Swiss people who travel frequently into the eurozone. U.K.-based Revolut whose competitive edge is providing favorable exchange rates and user-friendly processes, utilizes a European bank license obtained in Lithuania that is not valid in Switzerland. Revolut customers are not getting access to a Swiss bank account implying that funds are not included in the Swiss deposit protection scheme. We expect customers to utilize both players predominately as a secondary banking account, but currently do not consider it as a real alternative to traditional banks. Local mobile banks such as Zak, launched by Bank Cler, a subsidiary of Basler Kantonalbank and Neon, a collaboration with Hypothekarbank Lenzburg, have also emerged. Nevertheless, both are operating on a niche scale. All challenger banks face the problem of monetizing their customer acquisition costs by selling additional banking products beyond pure payment services.

Table 1

Technology Disruption Risk | Moderate

Switzerland topped the 2019 global innovation index, followed by Sweden and the U.S., with the country being a global hot spot for initial coin offerings (ICOs) and blockchain technology. Pleasant living conditions with high wage levels allow Switzerland to attract the best talent to foster technological innovation in the country's highly respected research institutes. That said, this leading innovative power has not been fully absorbed into the Swiss retail banking sector.

We consider that domestic banks' predominantly use a fast-follower approach in their retail strategies, not intending to become digital leaders. Swiss customers are not demanding pure online retail banking products and digital banks have not yet established alternatives to traditional banks. Surveys demonstrate that bank customers are overall happy with digital banking functionalities offered by their banks. Switzerland is working to establish an electronic identity (E-ID) valid nationally and internationally, but banking functionalities such as connecting banking apps with e-government or public transport platforms are not yet widely available. While cantonal banks offer mobile banking functionality, invest in improving cyber risk defense, and have digitalized a number of standard banking products, demand for digital products remains moderate with most banks waiting and seeing for customer demand to change. While this means that banks are not able to react quickly, it allows them to avoid sunk costs and to learn from developments in more digital banking markets.

Swiss banks have access to state-of-the-art technology benefitting from a good infrastructure, with Switzerland being for instance, a pioneer in the set-up of the 5G network. Banks are implementing new technologies and we expect domestic banks will be able to adopt visible new trends.

However, the full digitalization of bank processes and services is a long-term goal for most Swiss banks and, according to a 2019 SNB survey, digitalization targets differ significantly depending on bank size. The study not only reveals material gaps between the targeted and actual implementation of digitalization at most banks but also shows how larger banks are the most ambitious with their plans to digitalize elements of the retail banking value chain. These elements include the set-up of mortgage lending platforms and big data lakes, biometric identifications, and wide usage of robotics, while smaller banks would rather seek partnerships with fintechs to onboard innovative and convenient digital functionalities. In their efforts to lower running costs, smaller banks consider outsourcing but have generally limited appetite to develop solutions individually. We think that Swiss banks show overall good progress in digitalizing traditional banking processes and services, and there's no material risk of them losing headway in innovation against their tech competitors.

Most SNB survey participants saw more opportunities than risk from digitalization. Swiss banks expect increasing competition from digital banks and big techs in the mortgage financing and consumer loan segments, respectively. Switzerland is not a member of the EEA and is not obliged to fully implement the EU's Payment Service Directive 2 (PSD2), which intends to boost competition in payments and innovation toward open banking in the EU. However, to benefit from European cross-border payment infrastructure when exchanging euro payments, Swiss banks still need to comply sufficiently with regulation.

The banking association strives for private sector solutions to develop a framework that allows bank data exchange via dedicated application programming interfaces (APIs), with domestic banks united in their goal to prevent regulatory measures they cannot control. However, market participants were not yet able to agree on a common standard and numerous initiatives to build up open banking standards exist. For instance, supported by a number of larger domestic banks, SIX is setting up the Swiss Corporate API, that targets corporate customers and is supposed to allow participating banks to onboard payment and account services by third parties in a standardized way. Another example is the 'Open Banking Project' initiated by several market participants including leading domestic core banking service providers' finnova and avaloq. The Swiss NextGen API aims to allow structured access to essential information via APIs and also targets retails customers. It relies on the Berlin Group's XS2A framework--the leading technical framework in Europe to comply with PSD2. The standards are available on a developer portal including a sandbox for initial testing. The establishment of this framework would allow simplified onboarding of solutions developed within the PSD2 universe.

We anticipate that the lack of regulatory pressure will hamper the opening of payments and accounts to competitors and third parties. This will allow domestic banks to defend their franchises and customer bases against fintech or big tech companies in the short term. However, customers' expectations from banks are rising, and we think that effective collaboration between banks and fintechs will be key to the success of retail banking. Swiss banks should quickly agree on a common market standard, and individual banks should support the onboarding of digital services to differentiate against their peers and to fend off potentially rising competition from big tech groups in the medium to long term, in our view.

Preferences: Disruption Risk | Moderate

Switzerland remains far from becoming a cashless society, easily demonstrated by SNB's regular and popular press conferences to introduce new banking notes. The population's demand for cash remains high with its usage ranking among the top nations in Europe, in line with direct neighbors Germany and Austria. This is partly due to a cultural preference for safety and privacy, in particular in the German-speaking part of the country. SNB surveys reveal that the population still considers cash as being the most convenient when it comes to acceptance, user-friendliness, speed, and cost efficiency, but also uses it as a store of value. In line with the global trend, the share of transactions via contactless cards and mobile payments is steadily increasing, but we expect that cash will remain important in Switzerland, also considering the cash-friendly infrastructure with still lower card acceptance in rural areas.

Chart 3

With about 68% of individuals using online banking activities over the last three months, online banking penetration is slightly below the European average, according to data provided by the European Commission for 2018. Eurostat surveys comparing digital competencies across Europe and World Bank information on mobile and internet banking reveal a similar picture (see chart 3). However, digital banking remains popular with Swiss customers, and they generally assign good ratings to banks' mobile applications (see chart 4).

Chart 4

Customer behavior is changing gradually and domestic banks have already reduced their branch network by about 16% since 2009, in particular, Raiffeisen and the cantonal banks in rural areas (see chart 5). Postal offices and bank branches remain popular to pay monthly bills such as for rents and electricity but citizens overall less frequently enter branches for basic services including bank transfers or cash withdrawals.

Chart 5

Swiss customers still favor a relationship-based bank and prefer personal advisory for wealth management or for important life decisions, such as a first mortgage financing and pension plans. This is especially true for private banks, which in our view face minor competition from pure robo-advisers. While affluent customers will continue to demand personal advice, private banks are investing in their digital capabilities to improve the customer experience during the advisory and investment process. While not a disruptor, we think robo-advisers are here to stay, and will gradually capture investment management earnings from retail banks.

Generally, we see increasing customer interest in more complex digital banking products, yet final purchases are still made at branches. That said, we acknowledge customers are increasingly open to using online channels when it comes to consumer financing--also due to privacy reasons--and even refinancing of mortgages, but still consider a branch network to remain important. A massive branch dismantling for cantonal banks or PostFinance is also problematic for political reasons. This is due to their public status, their role as established banking providers, and their support of the local economy, often established in dedicated laws.

Similar to other countries, Swiss banks face the challenge of establishing customer loyalty by finding the right balance between staying physically close to customers while further developing digital channels and functionalities. It also remains critical for banks to teach customers how to use their services as Swiss banks are reporting more demand for telephone support from customers going digital. The focus has shifted from friendly service at the branch to other attributes, such as simplicity and convenience attributed to successful digital channels. That said, Swiss bank customers are among the most loyal core bank clients according to a study conducted by Bain & Company for 2016. They rarely switch their core bank relationship and, even after branch closures, product shopping at other banks remains very low when compared internationally. This customer loyalty somehow impedes a large rush to pure online banks, which still have a low presence in the overall banking sector and are not yet considered as a real alternative.

Regulation: Disruption Risk | Moderate

The Swiss Financial Market Supervisory Authority's (FINMA) banking regulation is characterized as generally conservative, demonstrated by early and best practice implementation of international standards, such as Basel III. Owing to the size and relevance of the banking sector in Switzerland, bank regulation frequently goes beyond international standards, and for instance, targets stricter requirements for capital quality and minimum capital ratios. High regulatory hurdles are another reason why the presence of foreign banks remains limited in Switzerland.

Our view on regulatory openness toward financial innovation is two-sided in Switzerland. As described, Switzerland is not obliged to adopt PSD2. We generally consider PSD2 as a long-term threat for European banks, but also as a trigger for the invention of digital financial services potentially by fintech and big tech companies. Switzerland has no plans to introduce a similar regulation and the Swiss banking association would rather seek market solutions, impeding the global trend toward open banking in Switzerland, in our view. The lack of a common market standard will hamper the implementation of third-party solutions and consequently digital innovations in the financial market. That said, it will initially help to protect banks' earnings and customer relationships against players from outside the traditional banking market. We also think that missing regulation will impair technology and business-model neutrality in the Swiss financial market given that banks can deny access to third parties.

Table 2

On the other hand, FINMA has recently established a framework to encourage innovation and competitiveness in the Swiss financial marketplace. The framework allows new players to operate under a sandbox approach or apply for a regulatory-light fintech license. This goes beyond the regulatory openness we see in most EU countries but remains in its design behind the U.K. and Hong Kong (we consider these jurisdictions to promote the most effective competition in regulated financial services; see table 2). Financial companies operating under a fintech license received by FINMA can accept public deposits of up to CHF100 million on the condition that funds are not invested and no interest on deposits is paid. This prevents them from competing with banks in the lending business. Additionally, the company`s core activities need to be based in Switzerland and the company needs to ensure they have implemented effective anti-money laundering and know your customer controls. Newly created fintechs can register under the sandbox approach that allows them to collect deposits up to CHF1 million before applying for any license. Before accepting deposits the fintech needs to inform a customer that its investment is not covered by the domestic protection scheme and the company is not supervised by FINMA (see table 3).

Table 3

This development will likely allow fintech companies to test their business models without applying for a costly banking license, for which approval can take up to six months with a capital base of at least CHF10 million. However, without a banking license, fintechs need to collaborate with a transaction bank if they want their customers to provide access to Swiss banking accounts. We think the Swiss regulatory framework will encourage the creation of fintechs operating in crowdlending or payment services, but do not consider their presence to constrain banks' main mortgage financing revenue. Switzerland remains an attractive place for company foundations in the financial market, with SEBA and Sygnum, two crypto banks recently obtaining banking and securities dealer licenses. Facebook's Libra Association has opted for Geneva as its base, attracted by Switzerland's principle-based regulation approach. The main use case for ICOs and cryptocurrencies is likely to be the safekeeping and investing of digital assets and start-up financing, but these activities should not directly interfere with domestic banks' retail operations.

Swiss Banks' Ability To Meet Customer Demand Supports Our Ratings

Our ratings on Swiss banks are among the strongest in a global context. Switzerland has a strong economy, with banks that are technologically well-equipped and in many cases benefit from explicit guarantees provided by their strong public owners.

We do not foresee any impact from potential retail banking tech disruption on our bank ratings in the near term. We consider banks meet current customer demand for a dual model that includes standard online and mobile banking services, but still retains branch banking for complex financial products. Nevertheless, we believe it might become more challenging for some banks to react to changes in customer behavior and to quickly reduce their branch networks, particularly if customers sway toward digital-only products and if open banking were to accelerate in Switzerland. This might result in banks losing headway against their peers, or new challengers outside of the traditional banking sector could weigh on individual bank ratings.

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