I have looked at the operations of some of the largest Nigerian banks and can arrive at one thing: the big banks are now platforms of huge ecosystems. If they continue the separations from the second- and third-tier banks, the latter group would fizzle or become extremely diminished within a decade. Platforms are efficient because they have both internalized and externalized capacities to grow through network effects at increasingly lower marginal cost. GTBank, especially, is now a technology company with a banking license. With its position in the market, few entities exist that can dislodge it from its vantage position.
The best modern technology businesses are platform-anchored, not product-driven. Facebook is a platform. Apple has a platform. Google runs as a platform. These are among the most valuable companies on earth. As marginal cost goes lower in the internet age, platforms will rise because of the positive continuum of network effects. From aggregation construct to one oasis strategy, businesses with consumer focused frameworks are wired to succeed if they are platform-oriented.
From Marginal Cost to Profit Margin (Net Income to Revenue)
Our banks recorded one of the best years in 2017. They made real money. And they did this even “while the sector’s non-performing loans soared from 5% in June 2015 to 15.6% last October, the IMF says”. Simply, they can make money as technology companies and not as banks. So, if you expect them to be making money from interest, you have not understood that the banks are now technology companies. And they belong to the platform category where money comes in small bits. In typical tech companies, you watch for marginal cost, in the banks you look for profit margin. Last year, the profit margin was great (the cost-to-income ratio, CIR, follows thus).Sources: Bloomberg and IMF staff calculations
I expect the profit margins to continue to improve. There is no reason why that should not be the case. The positive continuum of network effect will surely work for the banks. But as that happens, only the strongest will survive [I do note that most of the 2017 profits came from foreign currency floats, treasury bills, etc. Yet the transaction-fee income continues to grow faster than interest income. The banks will continue to innovate on extracting these fees].
The transition into a technology category means we are going to have some of the banks losing grounds. Yes, what typically happens in technology would happen here. As I noted few weeks ago in the Harvard Business Review, when the winner takes all, many casualties abound.
And global consumer technology powerhouses like Tencent and Google use customers to generate data that drives growth and revenues. These companies aggregate the data and scale massively with near-zero marginal cost, which is all made possible by the internet. Because they are ahead with an enormous number of users, they keep getting better, and the data they accumulate drives improvements in their algorithms. Changing this order is largely hopeless, and that creates a competitive stasis for local entrepreneurs.
In our banking, some of the leading banks will be the winners. There would not be space for the weaker ones because banks are simply competing within a technology domain and not necessarily banking ecosystems. Just as you cannot have many great search companies, social media companies and so on, Nigeria would not have many banks (yes technology companies with bank licenses).
These banks are now wired to make money under most circumstances: the currency crisis was a golden year for most.
Banks with net dollar assets were beneficiaries; GTBank, Nigeria’s most profitable bank – and its biggest by market capitalization – made N80 billion in 2016 from the devaluation, says its chief executive Segun Agbaje, or roughly $260 million at the post-devaluation rate.
FBN Holdings, the second-largest bank by assets, also recorded a N80 billion revaluation gain that year.
Zenith Bank, Nigeria’s biggest by assets, reported that derivatives income increased almost 250% to N68.7 billion last year – that’s equivalent to $225 million at the 305 rate,
Regulation Will Not Change the Trajectory
As our banks transmute into technology companies, regulating them would be more challenging. As I have noted, using Facebook, explaining that if you decide to break “Facebook apart, one part will grow and dominate others. This is possible because of the positive continuum of network effect where the biggest keeps getting bigger and also better. … You can regulate Facebook but another company will come to take over its position because in this sector, it is winner-takes-all. Yes, the best wins. Why? The scalable advantage improves with lower marginal cost”. Simply, there is an inherent nature that one company in a platform ecosystem will triumph at the end. Yes, few banks will win and many will go under in the retail banking sector.
And that is the problem. With their high scalable advantages running on aggregation construct, digital empires like Facebook and Google can take up offline empires, and may still not be within the crosshairs of the regulators. No one can effectively regulate Facebook, for example, unless you want another company (not named Facebook) to take its position. The operating structure of the business is mutative, and that means that it can grow through network effects which reward the best: a better service brings more users, and the more the users, the better the service, setting up a positive continuum. So, if you break Facebook, one part could grow and over time could dominate other parts, provided that part is the surviving best. Or another company with stronger advantage, post-Facebook breakup, would take over the new market and become the new category-king.
The Unification via BVN
With BVN (Bank Verification Number), many bank customers do not need to have many bank accounts. People have since consolidated especially in this age of huge fees where you pay for debit cards, and stamp duties for electronic transactions. Simply, customers will choose the banks they think are the best and stay with them. The rest would be closed, partly to avoid fees and mainly to simplify their lives. While banks would keep adding users [there are many outside the system], having more users is a lousy metric in Nigeria. What really matters in my opinion is the quality of the customers. As I noted few days ago, MTN Nigeria has seen ARPU dropped from $22 to $4.14 and truly struggles to make as much money despite having millions of more customers.
To help me understand the impact of WhatsApp and other OTT solutions, I pulled MTN Group financial report in 2006. In 2005 (yes 2005), MTN Nigeria was recording ARPU of $22. Today, it is $4.14.
So, you have to expand resources to support many customers and at the end you make nothing from many. The best customers are already with the leading banks. Leading banks like GTBank and Zenith Bank will become aggregators driving many smaller ones to edges. It is like Google Search giving Yahoo search a tough time. At the end, the best wins and most customers aggregate to it.
There is a massive consolidation happening in the Nigerian banking sector. I expect many of the smaller banks to exit the scene. Even if they remain, their impacts would be extremely marginal. Today, the market cap of GTBank is more than the whole sector if you remove the top two following GTBank. That disparity is showing in the profit margin of GTBank which is industry-leading (yes, that is the near-zero marginal cost typical in platform-based technology companies). With GTBank’s digital transactions growing 90% year on year, you would agree it is not a typical banking number. This summarizes it: add the impact of continuous digital penetration which will stimulate more platform benefits, the picture becomes clearer why 2030 may be too far for 50% of the players to exit (or if they remain, their impacts would be only marginal).
“There will be winners and there will be losers in the Nigerian banking sector as it becomes much more competitive,” says Ndiritu of Allan Gray. “I don’t think all banks are created equal in Nigeria.” There is still plenty of room for Nigeria’s banks to grow. The ratio of their assets to GDP was just 30% in 2015, compared with 55% in Kenya and 102% in Egypt, according to EFG Hermes, an investment bank. But with the easy money that has flowed from the state over the last couple of years drying up, it will be clearer than ever which ones are built to last.