What will be inside Adrian Gore's new bank

When Discovery’s Adrian Gore first announced that the insurance group planned to launch a retail bank it caused quite a stir. It was September 2015 and Gore (53) was presenting yet another set of stellar financial results — operating profit was up 17% that year — to a characteristically full house of analysts, the media and retail investors.

No insurance company can draw a crowd to its financial results quite like Discovery can. Even ostensible rivals, such as FirstRand and Standard Bank, in the typically "sexier" banking sector, would come off second-best.

People flock to Discovery’s results to watch Gore sell the story, televangelist-style. Inevitably, new products and international partnerships are also announced as investors get a glimpse into Discovery’s quest for world domination. Globally, think Apple, under Tim Cook or Steve Jobs.

But accustomed as investors were to lights, cameras and lots of action, no-one was quite prepared for Gore’s bombshell that Discovery would also be starting a bank. There was an audible gasp from the crowd; some seemed to have begun to clap.

Though Discovery will be entering a tougher field than when it launched its medical aid, its chances of success look good

Banking CEOs, no doubt, shed a tear: Discovery, the start-up that indelibly disrupted the medical aid and insurance industries, was planning to bring that same disruptive force to banking.

Fast-forward two years and Discovery Bank, this month, became the second new bank to obtain a banking licence from the Reserve Bank.

It followed on the heels of TymeDigital, which obtained its banking licence at the end of September and plans to target the lower-income segment of the market, as well as small and medium-sized enterprises. Commonwealth Bank of Australia — the largest listed company on the Australian Securities Exchange — is TymeDigital’s majority shareholder, with Patrice Motsepe’s African Rainbow Capital Investments holding a 10% stake.

Both banks will be branchless. But unlike TymeDigital, Discovery Bank will be going after the retail affluent market: those who fall within LSM 8 and above, with average annual income of around R300,000. In other words, exactly the customer the existing "big four" and Investec are desperate to retain, as they typically transact often and have more than one product, making them profitable for the banks.

Discovery Bank, which plans to launch before June next year, will be a formidable competitor in this niche, because its existing client base — in particular, highly engaged Vitality members — are largely more affluent. So Gore understands the behaviour of this market and he knows which levers to pull to influence it.

As he puts it: "We use our understanding of behavioural economics to design products that help people change the behaviour that influences risk."

In cuddly MBA-speak, Discovery describes this as its "Vitality shared-value insurance". But, since it is the "how" behind Discovery’s "why" (its effort to make people healthier), it will be heavily baked into its banking products.

"We believe that our shared-value model, which monetises better client behaviour for the benefit of the client and Discovery, has strong application in banking," says Gore.

So what will Discovery’s new bank look like? Though Gore is keeping much of the details under wraps, the Financial Mail has spoken to numerous people both inside Discovery and at its rivals to paint a picture of what will be the most widely anticipated launch in SA banking for decades.

Well, as Gore has said, it will look to mesh behavioural economics into savings accounts in an unprecedented way in the SA market. He believes there is plenty of opportunity for its "shared value" approach to disrupt existing banking models, given the "irrationality at play" in people’s savings behaviour.

"The Discovery Card is an early-use case in this regard. It offers clients rewards and benefits but is also highly profitable, generating a profit of over R350m per annum. It provides a high-quality client base from which to expand into further banking products," he says.

So the new bank will encourage people to save more and pay off debt — in the same way that Discovery Health encourages people to exercise regularly, Discovery Life encourages them to buy healthy foods, and Discovery Insure encourages people to drive safely through discounts on premiums.

Expect: low or no bank fees for those who save regularly; and dynamic pricing of interest rates on loans to reward people for "positive repayment behaviour" on home loans, vehicle loans or credit cards.

Just as Discovery has not relied only on traditional pricing methods in insurance, there’s every reason to believe it won’t necessarily rely only on traditional credit-scoring models when it comes to banking. Dynamic risk pricing — or insurance premiums that go up or down based on someone’s behaviour — has been Discovery’s hallmark in the insurance industry. Traditionally, policies are priced at inception based on factors such as age and gender, with little individual risk-based pricing beyond a claims history. Until now.

Gore’s company will invest R2.1bn into its new venture, which already has a staff complement of about 350 individuals. Much is being kept secret about this team, but it will be headed by Barry Hore — a former Nedbank and SA Revenue Service (Sars) executive. Hore was chief operating officer at Sars for nearly nine years, where he was highly regarded. He is credited with introducing e-filing and spearheading the tax authority’s transformation from a largely paper-based operating system to an almost completely automated environment.

Another key issue is: where will the customers come from?

For a start, Discovery will try to convert its 325,000 cardholders — the card, until now, has used First National Bank’s (FNB) licence — into full bank customers.

It’s a no-brainer, partly because its credit losses on the card are just 1.7% — less than a third of the wider 6% in the SA industry.

Gore says this attests to the "excellent quality of the client base".

Of course, Discovery is much smaller than its rivals. Standard Bank has 1.4m credit-card accounts, while Nedbank has 940,000.

But Discovery says the spending on each of its cards is more than double the amount spent on other credit cards in its particular segment.

"More than R25bn is spent annually through the Discovery Card and there are approximately 3m transactions per month," says Gore. "We attribute the high levels of engagement and spend to the compelling rewards and benefits that our members receive."

These rewards, which rivals often sniffily dismiss as "gimmicks", include discounts on healthy food, cheaper travel and interest-free debt for 55 days.

Gore says Discovery has highlighted "correlations" between a person’s status on Vitality (its loyalty programme) and spending habits. He won’t go into detail, saying this is "proprietary information".

But it’s no guess what this indicates: highly engaged Vitality members (individuals who are healthy and generally have their lives in order) are also, annoyingly, good with money.

The Vitality network gives it a rich source of data from which to draw behavioural insights. It now operates in 16 countries through seven insurers, serving close to 10m clients, with more than 150,000 new members added each month. In SA, Vitality has 1.7m members.

Remarkably, the global Vitality network houses 40m life years of behaviour-linked data. This is used to design individualised pricing and products.

This is perhaps Gore’s single biggest innovation in SA. It is also totally unsurprising, given that Gore (a fitness fanatic who has weighed a steady 71kg for years and who races up and down fire escapes to deal with stress) cut his teeth as an actuary at Liberty Life.

In 1992, he asked Laurie Dippenaar (one of the three FirstRand founders) if he could buy FirstRand’s dormant insurance licence. Dippenaar’s bank ploughed in R10m, and an industry was changed forever.

Until then, people paid a single medical aid premium for every benefit under the sun. Using behavioural economics, Gore created the "medical savings account", encouraging people to only use what they needed.

Today, Discovery’s medical scheme is a gorilla, with 2.7m members — twice as large as the next five largest open medical schemes combined. Slick marketing helped — as it surely will for Discovery Bank.

Banking rivals have done the honourable thing and welcomed the competition — even if they are quaking in their boots.

Competition can only be positive for the larger growth dynamic of the sector, which opens opportunities for employment and provides more choice for customers," says Nedbank’s Ciko Thomas, managing executive for retail and business banking.

Peter Schlebusch, Standard Bank’s CEO of personal and business banking, says: "We compete against all banks. Our customers have a choice to go [to any bank] at any time. I don’t think we should be fixated on Discovery Bank." He says Standard Bank won’t be changing its strategy to respond specifically to Gore. "We will continue to be the best version of ourselves," he says.

"Retail banking," says Schlebusch, "isn’t rocket science. It’s about delivering a great product, conveniently, with limited friction and at the right price point."

But this is more difficult than it sounds. Customers are far from happy with their choices, if the banking ombudsman report is to be believed. Last year, customers opened 5,219 cases against 17 SA banks. More than half related to fraud, but there were other complaints too, often relating to poor service.

In line with its size in the SA market, Standard Bank drew the most complaints (1,279), followed by FNB (1,036), Capitec (948) and Absa and Nedbank (both 888).

Schlebusch admits that keeping customers happy is tricky. This is why the bank is spending about R14bn/year on IT upgrades, according to Allan Gray.

"We’re trying to ensure we can render all our services online so that people can consume where they want to, when they want to," Schlebusch says — adding that 90% of all the bank’s transactions are done online.

Standard Bank may not have a specific response strategy to Discovery’s debut, but it has identified which customers "are most at risk" — those who have monthly debit orders to Discovery and Vitality.

"A lot of those customers are more digitally savvy. We have to make sure we look after those customers really well," says Schlebusch. He quickly adds: "We have to make sure we look after all our customers really well. Ultimately it’s a volume and scale game."

Discovery’s loyalty scheme — Vitality — could be a big swing factor. While most banks have some such scheme (FNB has eBucks, Standard Bank has 800,000 UCount rewards members), Vitality’s 1.7m membership base is a big drawcard.

So which banks are most at risk from Discovery’s entry?

Harry Botha, an analyst at Avior Capital Markets, says Standard Bank and Absa (who service the broadest markets) have the least to worry about. "Nedbank and FirstRand are more concentrated in the retail affluent market segment and are most at risk," he says. "They also have a higher proportion of customers with a Discovery product than Standard Bank or Absa."

FNB may be more exposed but its powerful rewards programme, eBucks, offers some protection. It has a larger membership base than Vitality since virtually all of the bank’s retail customers get signed up for eBucks automatically.

eBucks members are also highly engaged (its spend-to-earn ratio is 85%), and, at 17 years old, it is SA’s most successful rewards programme. "Vitality is to Discovery what eBucks is to FirstRand — a rewards programme that keeps clients sticky," says Neelash Hansjee, a senior investment analyst at Old Mutual Equities.

Like Vitality, eBucks rewards certain behaviour among FNB’s customers — chiefly, their use of the bank’s digital channels, and their use of more of the bank’s products.

Johan Moolman, eBucks CEO, says: "If you bank well, transact well, invest and insure with us then the programme becomes really rich, which is why we’ve been around for 17 years."

Having invested more than R9bn in the programme since the start (paying out R1.5bn in eBucks rewards last year), FNB won’t be willing to cede ground to Discovery.

Though FNB doesn’t call eBucks a "shared value" programme, it is founded on a similar premise.

Says Moolman: "If we don’t create the behaviour change, then we won’t have a programme, because that is where we get the money from to reward customers".

A bunfight between SA’s two most successful loyalty programmes is a tantalising prospect — with deep implications for the banks attached to both.

Perhaps Discovery Bank’s greatest competitive advantage, however, is simply that it is starting from scratch. It offers the rare opportunity to build the bank exactly how it wants, without clumsy and expensive legacy systems or costly branches. It’s a luxury the big four banks, which have spent billions upgrading old systems, would kill for.

Numerous anecdotes illustrate why this is an advantage. One Standard Bank client recently had R500,000 deposited into his bank account but was contacted by the bank only months later, when a teller spotted the sum by chance, to ask him if he wanted to invest it. In another case, an Absa customer opened an account at a different bank and her salary was no longer being deposited into that account. Yet, only when she went into an Absa branch to close her account, did the bank bother asking why she was leaving. And this is a common phenomenon.

Michael Jordaan, FNB’s former CEO, says a bank starting today has a huge advantage. "The ideal is one integrated system that doesn’t require a home-loan customer to fill in a form if they already have a current account — and where the financial, risk-management and regulatory data are all consistent and immediately available. This means better customer satisfaction, lower operating costs and better risk management," he told the Financial Mail.

Paul Bosman, a fund manager at PSG Asset Management, says new banks also need fewer staff. "There is a definite latecomer advantage for new entrants into this sector, as building new technology platforms is far cheaper than trying to merge or upgrade old legacy systems."

The obvious problem, however, is the cost of wooing new customers.

But Jordaan says that in Discovery’s case, this will be easier as it already has a well-established brand and existing customers.

Bosman agrees. "Discovery is in a very good position to cross-sell to existing Vitality members, especially as they are masters of influencing customer behaviour."

Still, switching customers out of their existing banking relationships, which in many cases span years and multiple products, into a new relationship, will be no mean feat. As much as someone might hate their bank, switching can be a hassle.

This has not escaped Gore, who knows his bank faces a tough fight. "Banks are strong, remarkably well run, innovative and full of technology. This is not an easy thing to do, but we believe we can do it," he says. "The banking market is huge and growing — it’s just about whether you can take market share from others."

Bosman expects Discovery’s bank to be very competitive. Its lower cost base (thanks to leaner operations and cheaper client acquisition off the back of cross-selling to existing customers) will help. "This business has a management team with proven ability in financial services and who are highly motivated, through very large shareholdings, to make a profitable success of their new venture," he says.

Jordaan points out Discovery has done pretty well by entering into new markets. "What started as a health insurer, quickly also became a life insurance company, then an investment provider and even a short-term insurer. Banking is complex and they will have recruited a team of experts, but Discovery has lots of generic knowledge about financial services, which will help."

Discovery will no doubt poach other top-notch candidates from banking rivals. But Schlebusch says Standard Bank has "lost very few people to Discovery Bank and has taken some very good people from them". This includes two of Discovery’s "most senior actuaries" who were putting the bank plan together.

But even assuming the bank has the A-team and a killer proposition, many will ask whether it’s sane to launch a bank in the current economic, political and regulatory environment.

The graveyard is full of wannabe-banks that launched amid great fanfare, but died soon afterwards. In 2001, 20twenty launched as SA’s "first online bank", backed, unfortunately, by the doomed Saambou. 20twenty was bought by the UK-listed Standard Chartered for nearly US$10m in 2003, but slowly dwindled and was quietly closed in 2005.

Christo Davel, the former CEO of 20twenty (and the brains behind savings tool 22Seven), says it’s easier to launch a bank now than ever.

When 20twenty launched, online banking was a fledgling industry, not trusted by many.

While Davel does not believe 20twenty was "before its time" as some say, he says shifts in macro trends — chiefly, the supremacy of the customer — make today a very good time to launch a bank. "The power of customers is making it easier to bring decent products to market. Customers demand good products, at a good price with a good experience."

It coincides with regulators placing more power in the hands of consumers, through legislation, such as the Consumer Protection Act and Treating Customers Fairly in SA.

Overseas, this trend has been given a boost by new rules — the European Commission’s second payment services directive (PSD2), which comes into effect next January — which will require banks to open their payments infrastructure and customer data to third parties, who can then provide payment services to bank customers.

This push towards "open banking" will be a revolution. Alasdair Smith, chairman of the retail bank investigation at the UK’s Competition and Markets Authority, says that for the first time, "innovative and secure apps will provide personalised services and information to cover all financial needs in one place, and make it easy for people to find out what bank account is best for them".

Unsurprisingly Davel’s team are building something that aims to operate in this "open banking" market, when it comes to SA.

Davel foresees a future where it will be much easier for customers to compare how banks charge and for what. For banks, it isn’t necessarily good news, as this will squeeze their margins and expose inefficiencies.

Davel expects Discovery to offer "a very smart product to their existing customers".

If it succeeds, it is likely to make Discovery a more formidable competitor than it is already. For investors who have benefited from Discovery’s 432% price rise over the past decade (and 26% over the past year), it could represent another windfall.

Jordaan believes Gore will make it work.

"Much depends on their choice of technology and whether they can bring the benefits of a modern, agile and low-cost banking platform to customers."

He is right to be cautious. Discovery Bank won’t be launching into the same inefficient market its medical aid was able to exploit.

And, as Moody’s pointed out in a report last week, Discovery’s "ambitious expansion initiatives" also present "execution risk and require significant amounts of external funding". The R2.1bn to launch the bank, plus the excess capital needed to be held as a buffer in reserves, will increase Discovery’s debt and suppress its return on capital.

But despite this caveat, Moody’s gave Vitality a glowing review, saying it was attracting the right types of customers.

Gore won’t be intimidated. He launched the Discovery medical aid two years before SA’s first democratic election, and says he’s still motivated by the fact that Discovery has a "mission".

As he told the Financial Mail last year: "If you think of most financial services companies in our ecosystem and globally, they don’t stand for anything. We do. Our model is to make people healthier, our [raison d’être] is then fundamentally different from most companies that simply want to make a profit."

If his bank succeeds in the way Gore envisions, you can bet South Africans’ spending habits will be profoundly changed too.

ziadyh@bdlive.co.za