South African banks command a good reputation and financial performance because of their strong governance and regulatory oversight. They have strengthened their business models through adopting new technology, specifically online banking in the 1990s and mobile banking more than a decade ago. Banks' consistent profitability through economic cycles enabled them to stay ahead of the curve and accelerate their revenue diversification strategy.

South Africa has been a key destination for technology investments. Leading U.S. companies in mobile and security software have operations in South Africa and contribute to train local skills. This helped banks adopt fintech products while developing their own capabilities. We think that disruption risks stemming from neobanks is limited because banks work together with fintech startups and regulators through incubator programs and the sandbox environment.

The South African regulator has been an early adopter of global best practices and supports banks' stability and perception of risks, including disruption risks from new technologies. The South African Reserve Bank (SARB) is encouraging banks to adopt new financial technology, even pioneering with other central banks a potential shared multi-central bank digital currency (CBDCs) platform for international settlements. In addition, regulation in South Africa is cohesive across various government agencies. In 2016, the SARB, in collaboration with other government agencies, created the Intergovernmental Fintech Working Group (IFWG) to regulate emerging risks from new financial products and assess opportunities in the market. This underscores our view of consistency and strong regulatory framework.

Mobile penetration, including the use of smartphones, is important in South Africa. But nonfeature phones that do not require an internet connection are also widespread. According to the National Treasury, 81% of adults have access to a bank account in 2023 against 63% in 2011, but weak economic growth and high unemployment are undermining further progress. Nevertheless, banks enjoy the population's trust, according to the 2023 South African retail financial customer behavior and sentiment survey. There are also large inequalities across consumers, affecting the way they bank. The pandemic shifted preferences of urban South Africans away from cash to mobile digital payments as e-commerce boomed amid stringent restrictions. Banks quickly expanded contactless payment solutions as daily spending increasingly moved online. More recently, large retailers have widened payment options with leading brands accepting cryptocurrencies. According to Statista, nearly 10% of South African owned cryptocurrencies in 2022 given a weakening rand, high inflation, and high cross-border payments costs.

TRIP Analysis Shows That South African Banks Face Low Disruption Risks

We base our views of disruption risk for South African banks on our four-factor analysis of the banking system's technology, regulation, industry, and preferences (TRIP).

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Technology: Disruption Risk | Low

A sophisticated ecosystem underpins South Africa's technology infrastructure

Despite chronic infrastructure decay, South Africa has been a key destination for technology investments. Leading U.S. companies in mobile and security software operating in South Africa deploy cutting-edge technology solutions and invest in human capital. Cloud-based services and data center infrastructure have gained momentum and underpin a buoyant sector that expands across the continent. This technology-friendly environment supports South African banks' business models centered on transactional banking.

Broadband infrastructure and access to the internet in South Africa is broadly comparable with that of emerging markets such as Mexico and Brazil, although it lags that of developed countries. In 2022, 78% of South African households had access to the internet through 3G, 4G, or LTE and 5G (20%) according to the Independent Communications Authority of South Africa. However, the aging electricity infrastructure and chronic power shortages are undermining the reliability of internet access and development of fintechs. Although prices have declined since 2019, mobile data is still more expensive in South Africa than elsewhere on the continent, ranking 20th out of the 50 African countries, according to cable.co.uk.

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According to the Global Enabling Sustainability Initiatives' Digital Access Index, South Africa ranks 64th of 157 countries in terms of access and use of new information and communication technology, with a normalized score of 0.56, comparable with that of Mexico and Brazil. The digital access index reflects 21 indicators grouped into infrastructure (such as 4G network coverage and the number of internet exchange points), use (smartphone market penetration and fixed/mobile broadband subscriptions), affordability (cellular tariff cost and mobile-specific taxation costs) and technologies (cellular machine-to-machine connections and social media penetration).

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South African banks enacted their online banking platforms in the late 1990s and the first banking application was launched in 2011. As key stakeholders in the South African financial system, they realized early on how technology can accelerate their strategic goals, including improve financial inclusion. Banking services in South Africa are well developed and have had integrated advanced loyalty programs for more than a decade. Technology available to banks let them harness customer data and tailor their services across segments. Technological transformations and digital banking products have also helped them optimize costs, despite a decade of weak economic growth. Leading banks improved efficiency and met changing customer needs in response to the pandemic-related economic restrictions. They deployed contactless technology very quickly and met the requirements of the booming e-commerce. IT expenditure has been steady for most banks, given their previous investment strategy. They averaged 10% of operating expense for the top five banks in South Africa over the past five years.

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Banks have started implementing cloud computing, with progress dependent on the extent of their legacy systems. Technology infrastructure built on modern cloud-based infrastructure will enable scalability, responsiveness, and efficiency.

Banks enacted fintech products through application programming interfaces, including for payment. For example, major South African banks use digital identification designed by fintechs on their banking apps. Other products related to SMEs and payments are developed by fintechs and intended for banks. Open banking has not been implemented yet in South Africa, but the SARB in collaboration with the National Payment System Department (NSPD), issued in 2020 a consultation paper on open banking activities in South Africa. This is in response to the growing demand from third parties for customers' financial information, notably the need for real time payment confirmation in e-commerce. Open banking has the potential to broaden access to finance, enhance market competition, and expand the financial services ecosystem.

Although the use of artificial intelligence and big data is emerging, we think this will ramp up as banks complete the migration of their systems to the cloud. Banks' use of AI is limited to chatbots on internet banking platforms and banking applications. Once fully implemented, AI and big data will lead to several benefits for banks, including process automation, enhanced credit scoring, fraud detection and prevention, and risk management.

Regulation: Disruption Risk | Low

The regulatory approach minimizes risks for banks

Despite its conservative approach, the SARB is encouraging banks to adopt financial technologies and has pioneered, along with other central banks, a possible shared multi-CBDCs platform for international settlements. We think disruption risks from regulatory stance is low because regulatory settings allow banks to operate in partnership with fintechs.

In 2016, the SARB, with other government agencies, created the IFWG to regulate risks from new financial products and assess opportunities in the market. In 2018, the SARB and top South African banks explored the potential of interbank settlements using distributed ledger technology in Project Khokha. The project's second phase in 2021 looked at tokenizing securities ahead of the CBDC's adoption.

In addition, the IFWG launched its inaugural regulatory sandbox (RSB) in April 2020. Although project retention rate has been low (less than 20%), it targeted a wide array of applications related to cross-border payments, crypto assets, crowdfunding, insurance, and lending. The RSB seeks to provide regulatory clarity to participants and industry more broadly, and inform policy and regulatory responses.

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South Africa regulatory framework follows the twin peaks model, where the SARB is the prudential regulator and the Financial Sector Conduct Authority (FSCA) is the market conduct regulator. Fintech licensing falls to the FSCA, but other government agencies could be involved, including the Financial Intelligence Centre, National Payments Association of South Africa, and the National Credit Regulator.

Considering the growing adoption of cryptocurrencies, in 2022, government agencies through the IFWG adopted a comprehensive and proactive approach to regulate crypto assets considered financial assets to better position South Africa in developing the sector and managing anti-money-laundering and counterterrorism-financing risks. South Africa is still on the grey list. In 2018, the South African Revenue Services clarified its stance on taxation of capital gains on cryptocurrencies taxed at 18%. The FSCA requires licensing of crypto assets trading venues while bank customers can use their bank accounts to enter crypto exchanges. As a result, banks are developing their own blockchain infrastructure. Standard Bank of South Africa launched its Aroko payment platform in 2022, which leverages blockchain technology and smart contracts for end-to-end digital foreign currency payments and settlements for institutional and corporate clients. First National Bank is exploring the use of blockchain to issue e-title deeds while Investec Bank looked at the custody service and reporting of crypto assets through its Digital Asset Vault.

Mobile money has had less momentum in South Africa relative to other African countries such as Ghana and Kenya, because the banking sector caters to various segments of the population and the regulatory landscape is considered more stringent. Mobile money operators that offer wallets to customers are deposit taking institutions and require a banking license to offer this type of service. South African banks launched Payshap, an instant mobile service to transfer money across banks, using a mobile number for example. However, telecom companies have not been able to take advantage of their scale to expand their mobile money services. MTN first launched its mobile money platform in South Africa in 2012 before closing the service in 2016 owing to lack of commercial viability; Vodacom shuttered its M-Pesa mobile money service in South Africa the same year. M-Pesa, initially launched in Kenya, is the most successful mobile money platform in Africa.

Industry: Disruption Risk | Low

Fintechs challenged payments services and banks responded by embedding payment options

Neobanks are unlikely to reshape competitive dynamics in the next couple of years because most of them rely on other banks or retail networks to operate. Challenger banks such as Tyme Bank, Discovery Bank, and Bank Zero, which all launched in the past five years, are digital and have a very small market share (less than 0.5% to date). The South African banking sector operates with few and strong banks. Top-tier banks control about 90% of system assets.

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Banks used their dominance as key stakeholders in the financial system (including the national payment system), reputation, and financial strength to set up incubators and collaborate with fintechs to ultimately embed their products in their banking platforms and build their own digital capabilities. There are about 150 fintech startups in South Africa across various subsectors including payments, lending, insurance, investment, and blockchain.

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The South African fintech sector is relatively mature compared with that of African peers, accounting for 40% of all fintech revenue in the continent. However, fintech startup funding is lower than other hubs like Nigeria. Funding peaked at $205.9 million in 2021 before decreasing to $77.3 million in 2022. Low investor confidence from the country's economic woes could explain the slowdown.

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We think fintechs will continue to challenge and emulate banks in the payments space as they provide constant, cost-effective and efficient products, forcing banks to adapt quickly and collaborate to remain competitive. The payment services subsector accounted for the largest number of fintech startups in 2021 (27%), according to Statista. Fintechs in the payments space have been successful by offering online payment services, point-of-sale payment services for small traders, and cross-border remittances. The high migrant population also drives the demand for cheaper and faster cross-border money transfers and several fintechs, such as Mukuru, Mama Money, and Hello Paisa, operate in this space. Consumer habits changed in the pandemic's aftermath, which gave rise to contactless payments. Banks onboarded big technology companies' payments options such as Google Pay, Samsung Pay, and Apple Pay. South Africa is more advanced in contactless point-of-sale system implementation than other African countries, which will support growth in the segment.

Preference: Disruption Risk | Moderate

Despite high fintech adoption, cash transactions are still the norm in South Africa

We think disruptions risks are moderate because South Africa is an emerging market and cash economy, but trends are favoring digital payments.

Although 81% of the population above the age of 16 had a bank account in 2021, many account holders transact in cash. The relatively large informal sector (accounting for almost a third of the economy), together with high income inequality, mitigates retail customers' disruption risk for banks. A Stitch survey found that South Africans prefer cash because of the perceived high fees on digital transactions and convenience of cash. In addition, low digital financial literacy, as well as remoteness (about 30% of the population live in rural areas), curbs the adoption of digital money.

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Nevertheless, urban South Africans, which represent about 67% of the total population, have fueled the exponential growth of e-commerce since the pandemic. According to the 2023 Visa Discovery Spend Trend report, more than 50% of digital transactions in South Africa were contactless. E-commerce is expected to have grown a further 25% in 2023, according to BMI Research, while transactions could increase 150% by 2025 according to RMB. In addition, South Africa's relatively young population supports the need for more digital banking, with more than 50% of the population below the age 30. We believe young, educated, and tech savvy South African customers will continue to adapt more to new technology and value easy access to digital platforms. Most banking transactions are now largely done virtually via mobile apps, internet, and cellphone banking, at 70% in 2021 compared with 43% in 2017. Owing to the growth of online transactions, an estimated 957 branches (35% of the top four banks' total branches) closed over the past decade through 2022.

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Large South African retailers adopting cryptocurrencies will likely moderate the perception of risks associated with cryptocurrencies. Cryptocurrency adoption continues to increase in the country given a weaker rand and high cross-border payment costs. In 2022, nearly 10% of South Africans own cryptocurrencies; of those, almost 50% are 18-34 years old. Equally, South Africans have been investing in cryptocurrency (with a vast majority owning Bitcoin) to preserve value as the rand weakens. Regulated trading venues such as Binance (the world's largest crypto exchange) and ValR (headquartered in South Africa) recorded significant growth in trading volumes since 2020 because users can purchase cryptocurrencies using their bank accounts.

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Security risks, however, remains a deterrent. According to Interpol, South Africa had the highest number of cybersecurity threats on the continent, with 230 million threat detections in 2022. The banking sector had 26.8 million fraud incidents, resulting in $43.3 million losses. Nevertheless, banks remain the most trusted financial services providers, according to the South African retail financial customer behavior and sentiment survey. In the survey, 82% of respondents said they trust banks, compared with 28% for mobile money providers, 18% for money transfer providers, and 14% for microloan or cash loan providers.

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Banks Are At The Forefront Of System Innovation

South African banks have been early adopters of technology in financial services and operate on par with banks in developed markets. They introduced online banking even when internet and mobile penetration was low. They are well positioned today to continue their transition to the next evolution of banking with technology such as blockchain and artificial intelligence. Their success largely stems from their ambition to grow transactional revenue in markets that operate in cash. Equipped with a goal to deepen their reach across products and payment services, they combined forces with fintechs to drive change in customers' behaviors.

Similarly, the pandemic triggered a behavioral shift among South African customers in favor of digital payments when forced to purchase products and services online. The capital trust that banks hold among consumers uniquely position them to reshape the industry and cater to various segments of the population and the economy. A proactive regulatory stance is central to the pace at which banks will adapt, evolve, and avoid disruption. The speed at which new technologies come online will shape the future of banking in South Africa.