Annual Report 2017

Q1: You recently spoke about a return on equity (ROE) target of 13%. It is a level that DBS has barely achieved in the past; at the same time, banks are finding it difficult to maintain their historical returns because of more stringent capital requirements. Why would it be different for DBS?

A: Our ROE since 2010 has been around 11%, similar to the preceding decade. Normalising for allowances, our 2017 ROE would also have been at that level. However, the underlying returns of our business have been rising since 2010. Wealth management income has quadrupled during the period to SGD 2.11 billion and now accounts for 18% of group income, while cash management income crossed SGD 1 billion this year from almost nothing. Both are low-capital-usage and high-returns businesses. The proportion of capital-intensive trading income has halved to one-tenth of group income. These improvements have been masked by the low interest rate environment and a build-up of our capital, both of which are now being reversed.

Interest rates have been low over the past decade. Three-month Singapore-dollar interbank rates, the benchmark for pricing domestic loans, last peaked in 2006 at 3.5%, declined during the global financial crisis and then stayed below 1% until 2015. Since then they have been hovering around 1%. With reflation in the global economy well under way, the general view is that interest rates around the world are on a cyclical upturn. Given our balance sheet structure, a one-percentage-point increase in domestic interest rates roughly translates into a one-percentage-point improvement in ROE.

With the publication of Basel regulatory requirements in December, we finally have clarity on capital requirements. The impact on us is not significant – risk-weighted assets rise by only 5% on a pro forma basis when the rules are fully implemented in 2022. The capital we have been building up because of the uncertainty can now be returned. The special dividend of 50 cents per share is the initial step to recalibrate our Common Equity Tier 1 (CET1) ratio closer to our long-term target of 13% compared to the 14% we have been operating on. Barring unforeseen circumstances, we are also raising the annual payout to SGD 1.20 per share. The reduction in CET1 will be another driver for improving ROE.

A third ROE driver is the improvement to the cost-income ratio that digitalisation brings. Digitalisation enables us to increase wallet share at lower marginal costs in developed markets and scale profitably into the granular SME and mass consumer segments in emerging markets. These gains should reduce the cost-income ratio by at least half a percentage point annually in the near term. Over the intermediate term, the rate of cost-income ratio improvements will pick up if our digital strategy enables emerging markets to contribute more meaningfully to DBS. A five-percentage-point improvement in the cost-income ratio translates into a one-percentage-point improvement in ROE.

These three drivers will contribute to DBS’ ROE at their own pace and cycles, but their combined effect should result in a discernible improvement in our returns over the next few years. We believe a ROE of 13% is readily achievable.

Q2: How do you feel about DBS at 50?

A: DBS at 50 is an amazing success story.

Our story is intertwined with Singapore’s, and our achievement mirrors hers.

In our early years as the Development Bank of Singapore, we anchored Singapore’s development as a manufacturing and financial hub. During our adolescent years, we expanded out of Singapore. While we learnt some lessons along the way, DBS has built a credible regional franchise.

Today, we are Southeast Asia’s largest bank, with a diversified franchise across businesses and geographies. Our credit ratings are among the highest in the world. In the past few years, we have also been increasingly recognised for our leadership in Asia.

But at 50, DBS is at a crossroads. So, too, is banking. What is clear is that what has got us this far will not take us into the future.

With the digital revolution, banking is being fundamentally redefined. The ubiquity of the mobile phone is rendering the paradigm of going to the bank, or an ATM, or interfacing with the desktop, irrelevant. The explosion of big data means that as we go forward, a huge part of the battle for the customer will be fought along data lines. With the rise of the network economy, there is also no longer a premium on scale.

While the pressure is on, it is not all doom and gloom. Banks have some innate advantages: robust networks and infrastructure, and established risk management frameworks. We are also generally seen as safer and more trustworthy.

To successfully navigate the change, however, banks have to embrace what the big tech companies do. We need to develop new ways of working, and organisational culture has to be more customer-centred and data-driven.

I am optimistic that DBS will make the transition well. With 24,000 people, the bank is of a “Goldilocks size” – big enough to matter but small enough to be nimble. In the last few years, we have made significant strides in advancing the digital agenda. Today, digital innovation in the bank is pervasive and cuts across all units, from front to back.

Few people realise that when DBS was formed in 1968, we were younger than many of our local competitors – a “Johnny-come-lately”. As a latecomer to the scene, our people had to constantly innovate and think out-of-the-box to gain market share. Fifty years on, that same spark which helped finance the development of Singapore is spurring us on to become a future-forward bank.

Q3: DBS, along with its Singapore peer banks, has come under the spotlight for lending to controversial sectors such as palm oil and coal. Does DBS have plans to exit these sectors?

A: Let me say that even though being purpose-driven is becoming a cliché in today’s business world, the truth is that DBS does have this sense of purpose embedded in our DNA. This comes from our roots as a development bank, created for the express purpose of helping Singapore’s industrialisation, as well as our heritage in POSB, where “Neighbours first, bankers second” is more than a tagline. We recognise that not all returns can be found in financial statements. Our responsibility to shareholders is complemented by our responsibility to society at large.

Climate change is one of the biggest challenges facing mankind. We are therefore committed to taking a leadership role in promoting sustainable development, including the transition to a low-carbon economy.

However, it would be foolhardy to assume that the transition can happen overnight.

In ASEAN, 65 million people remain without access to electricity today. While the region has made efforts in adopting low-carbon energy, by 2040, coal will still account for 40% of the generation mix to support the region’s economic and population growth¹. To tackle climate change, developed and developing countries made differentiated pledges based on their respective financial and technological capabilities, levels of economic development, limitations and needs.

Given this reality, we have adopted a framework that allows us to make meaningful impact in a planned and phased way. Our philosophy is anchored on three principles:

1. In developed markets, we will actively finance sustainable alternatives given that factors such as grid capacity, electrification ratio and tariff reform present a relatively mature environment for renewable energy.
2. In developing markets, we will pursue viable renewable projects, and at a minimum, direct our financing towards more efficient fossil-fuel-based technologies. We will also work with clients to establish safeguards in line with regulation and best practice.
3. We will rebalance our portfolio towards sustainable activities by consciously seeking such projects to work on.

In line with this philosophy, we have decided to discontinue financing new greenfield coal-fired power generation projects in developed markets. In developing markets, we will be changing our focus to more efficient technologies. On coal mining, we will cease project financing of greenfield thermal coal mines going forward. Our commitment reflects a balanced approach to the energy trilemma – the trade-off between security, affordability and sustainability of supply.

Similarly, palm oil accounts for the livelihoods of millions of small-scale farmers and the accompanying supply chain in some of the most populous countries in our neighbourhood. It is a highly versatile and productive crop. However, its production, if not conducted properly, can have negative impact on the environment, economy and people.

While our credit exposure to palm oil is not material, we promote sustainable production by being discerning in our lending practices. We now require new lending relationships in the sector to demonstrate alignment with no deforestation, no peat and no exploitation − otherwise known as NDPE, the best-in-class policies that are increasingly being adopted in the palm oil sector. We will also consider new customers who have achieved Roundtable on Sustainable Palm Oil (RSPO) certification or are able to demonstrate that they are working towards achieving RSPO certification within a satisfactory timeframe. These commitments must include a zero-burning policy.

In 2017, we started the systematic integration of environmental, social and governance risk factors into the credit assessment process. This is a milestone for our responsible financing agenda. We do this not only to protect our reputation, but also because it is the right thing to do.

Read more about our responsible financing approach here.

¹Source: Southeast Asia Energy Outlook 2017, International Energy Agency