The bank going after rich South Africans – and winning

Since its inception, Discovery Bank has focused on maintaining its high-quality client mix, which has enabled it to grow rapidly and avoid the worst effects of higher inflation and interest rates. 

The bank has shown tremendous growth since it began operating in 2019. Discovery’s latest interim report showed it surpassed 825,000 clients and crossed R16 billion in deposits.

It also has reached the important milestone of monthly operational break-even ahead of plan, meaning the company generated a profit before accounting for new business acquisition costs. 

Discovery Bank launched on 14 November 2018 and is marketed as the world’s first fully digital behavioural banking platform.

It aimed to leverage the existing client base with its parent company, Discovery, to disrupt South Africa’s incumbent financial institutions. 

Discovery Bank’s shared-value approach is based on a win-win system in which clients manage their money well, creating less risk for the bank. 

This enables the bank to offer clients benefits, such as reduced interest rates, based on their personal data and money management. 

The behaviours that are rewarded include saving, being adequately insured, investing for retirement, and paying off home loans faster. 

Vitality Money can be used on rewards like a dynamic interest rate increase for a savings account, getting up to 100% back on HealthyFood, and a 75% discount on HealthyCare.

The interplay of its shared-value proposition is clearly seen in its new home loan offering, launched last month, which illustrates the bank’s business model. 

As with any financial product, home loans are dominated by the country’s ‘Big Four’ banks – Standard Bank, FirstRand, Nedbank, and Absa – which provide finance for around 90% of all home loans. 

To disrupt this market, Discovery Bank has leaned heavily on its shared-value proposition and its ability to leverage clients within the larger Discovery ecosystem. 

The bank has identified around 20% of Discovery’s clients who have existing home loans with other financial services providers. Their mortgages are mispriced, which presents a huge opportunity. 

These clients are the low-hanging fruit the bank hopes to win over quickly before taking on the established players and competing for new homeowners. 

“The unique nature of home loans means client and asset risk typically reduce over time,” CEO Hylton Kallner said.  

“With high costs negatively impacting repricing or switching to a different bank, an estimated 60% of clients are overpaying on their existing home loans today.” 

In an interview with Daily Investor, Kallner said one key factor in the bank’s sustained growth is its conservative approach to growth and focus on a high-quality client mix.

He explained that the bank’s growth and deposit base of over R16 billion has given it a good runway with new products and allowed it to fund its home loans service entirely off its own balance sheet. 

This is based on the bank’s high-quality client mix, which is over-indexed to wealthier South Africans and thus lower risk. Discovery Bank has managed to maintain this mix throughout its growth trajectory. 

Most of the bank’s clients are classified as low risk or exceptionally low risk, with almost none of its new business coming from high-risk clients. 

As such, it is not exposed to the headwinds associated with high interest rates in the same way as some of its peers are. 

Kallner has been clear about the bank’s cautious approach to its growth and conservative financial goals. 

This results in the bank also having tight lending standards and leveraging its shared-value model to lower the risk of its clients. 

In the company’s latest interim results, its deposits were around three times greater than its loans and advances – reflecting a very conservative approach to lending. 

Its deposits grew 31% to R16.67 billion, while advances rose by 20% to R5.75 billion. 

Thus, while the bank’s peers, particularly the Big Four, have been hit by a sharp rise in non-performing loans and are closing their lending taps, Discovery Bank has kept this under tight control. 

This can be seen in the graph below, which shows Discovery Bank’s non-performing loans (the solid blue line) compared to the average of South Africa’s four big banks (the dotted line).