We believe we are the only bank to have developed a methodology for measuring the financial value created by digitalisation. And because one can manage only what one measures, we have been able to draw up an effective business plan to drive digital behaviour among customers.
Record performance underscores quality of customer franchise enhanced by digital transformation
We achieved record net profit of SGD 4.39 billion in 2017, up 4% from the previous year, driven by broad-based growth in loan volumes and fee income. Total income rose 4% to a new high of SGD 11.9 billion as we captured opportunities in a reflationary environment across the region. Business momentum accelerated over the course of the year; quarterly total income crossed SGD 3 billion for the first time in the third quarter and, despite seasonally lower non-interest income, stayed above the mark in the fourth quarter.
The growth in business volumes more than offset the impact of a weaker trading performance and lower net interest margin, which caused a combined drag of three percentage points to total income. In addition, total net allowances increased 8% to SGD 1.54 billion as we accelerated the recognition of residual weak oil and gas support service exposures as non-performing assets (NPA). The step was taken to remove uncertainty about the outlook for asset quality and earnings in 2018.
Digitalisation contributed significantly to the increase in total income by boosting our share of customers’ wallet. At the same time, it lowered customer acquisition and transaction costs. Together with other cost management initiatives, digitalisation enabled expense growth to be contained to 3%. Profit before allowances increased 4% to SGD 6.79 billion. The performance underscored the breadth and nimbleness of a customer franchise enhanced by digital transformation.
Capital and dividends
Uncertainty about the impact of Basel III capital reforms had led us to build up capital buffers in recent years. Our fully phased-in Common Equity Tier 1 (CET1) capital adequacy ratio of 13.9% and our leverage ratio of 7.6% were well above regulatory requirements.
On 7 December 2017, the Basel reforms were announced. They pertained to revisions to the standardised approach for calculating credit risk, market risk, credit valuation adjustment and operational risk; constraints on the use of internal models as well as the introduction of a RWA output ﬂoor based on the credit standardised approach. These revisions, together with changes known as the Fundamental Review of the Trading Book, will not be implemented until 1 January 2022. For DBS, the aggregate impact of these rule changes and the changes to the standardised approach for counterparty credit risk effective 1 January 2019 will be benign, increasing RWA by about 5% on a pro-forma basis.
The Board therefore suspended the scrip dividend with immediate effect. It also determined that ordinary dividends can be sustained at higher levels and affirmed the policy of increasing them over time in line with earnings growth. For the final dividend of 2017, it proposed a payout of 60 cents per share, which will bring the full-year ordinary dividend to 93 cents per share, an increase of 55% over the previous year. In addition, it proposed a special dividend of 50 cents per share as a one-time return of the capital buffers we had built up and to mark our 50th anniversary in the coming year.
Total shareholder returns for the calendar year amounted to 47%, comprising a 43% appreciation in the share price and a dividend payout of 63 cents per share (consisting of the 2017 final dividend of 30 cents and 2018 interim dividend of 33 cents). The returns exceeded the increase in net book value per share of 6% to SGD 17.85. DBS had a market capitalisation of SGD 64 billion at 31 December 2017.
For the coming financial year 2018, we expect to pay a dividend of SGD 1.20 per share barring unforeseen circumstances.
Broad-based growth in customer franchise
Loans increased by an underlying 9% or SGD 25 billion in constant-currency terms. The growth broadened and accelerated over the course of the year. The consolidation – in Singapore, Hong Kong, China and Taiwan – of the retail and wealth management business acquired from ANZ added another SGD 8 billion of loans, resulting in overall constant-currency loan growth of 11% or SGD 33 billion. The reported overall loan growth was four percentage points lower at 7% due to the appreciation of the Singapore dollar against the US dollar.
Consumer and corporate loans contributed evenly to overall loan growth. In constant-currency terms, consumer loans rose 17% to SGD 109 billion after the ANZ consolidation. Our market share of Singapore housing loans crossed 30%, rising two percentage points for the third consecutive year to reach 31%. After contracting for the past two years due to the absence of onshore-offshore RMB arbitrage opportunities, trade loans expanded 25% to SGD 45 billion from growth across the region. Non-trade corporate loans increased 6% to SGD 171 billion, led by real estate and deal-related financing for Singapore and Greater China corporates.
Partially offsetting the loan growth was a five-basis-point decline in net interest margin to 1.75% as domestic interest rates used for pricing Singapore-dollar loans were on average lower than the previous year. The brunt of the year-on-year margin pressure was felt in the first half; net interest margin stabilised in the third quarter and was higher in the fourth compared to the year-ago period. As a result, the full-year net interest income growth of 7% to SGD 7.79 billion was due largely to the second half.
Net fee income rose 12% to SGD 2.62 billion from a wide range of activities. Leading the increase was an underlying 25% growth in wealth management fees as buoyant market sentiment boosted demand for unit trusts and other investment products. Increased fixed income and equity underwriting resulted in a 14% increase in investment banking fees. Transaction banking fees increased 6%, led by higher cash management income. Card fees were also higher due to higher credit and debit card transactions in Singapore and Hong Kong.
Digitalisation boosts income and productivity
Digitalisation was a major factor for the growth of our customer franchise during the year.
There are two principal reasons how digitalisation boosts operating performance. First, it lowers the costs of signing up customers and serving them − the marginal cost of transacting over digital platforms is significantly lower than for traditional methods where relationship managers or sales people are needed. Second, the convenience, ease of use and instant completion of transactions that digital platforms offer improve customer engagement. As a result, customers transact multiple times more than non-digital customers, giving us a higher share of wallet across all products. The higher level of engagement also results in consistently faster income growth for digital customers over time.
In the consumer and SME businesses in Singapore and Hong Kong, where the impact of digitalisation is most visible, digital customers formed 42% of the base in 2017 but accounted for a larger 63% of total income and 72% of profit before allowances. The return of equity (ROE) of digitally engaged customers was 27%, a significant nine percentage points higher than for traditional customers.
We believe we are the only bank to have developed a methodology for measuring the financial value created by digitalisation. And because one can manage only what one measures, we have been able to draw up an effective business plan to drive digital behaviour among customers. The intent is to make it easy for customers to sign up and transact with us online. The proportion of customers that are digital has risen nine percentage points since 2015 to 42% today, contributing to the improvement in the group’s cost-income ratio.
For top-tier private banking and large corporate customers, the differentiation between digital and traditional customers is less meaningful. These customers require solutions that are bespoke, necessitating regular engagement with relationship managers even as they increasingly transact digitally.
In the broader wealth management business, income has been growing at an annual 24% since 2014, when the impact of digitalisation began to be felt in earnest, compared to 18% for the five years before. The number of customers acquired digitally quadrupled from 2014 and now accounts for two-fifths of the total. By providing online research relevant to customers’ trading and portfolio to improve engagement, online equity transactions tripled. At the same time, productivity improved as relationship managers were provided with customer analytics on a mobile platform, raising the income per head in Treasures, our entry-level wealth management customer segment, by 57% over three years.
In the large-corporate business, a focus on embracing digitalisation and delivering agile solutions enabled cash management income to double since 2014 to over SGD 1 billion. Income grew 32% in 2017 with the launch of over 30 new solutions including corporate multi-currency accounts and cross-border pooling, a world-first online solutioning and advisory platform as well as a comprehensive suite of corporate and institutional application programming interfaces. Growth was broad based across all priority markets as we worked with corporates to enhance their digital commercial ecosystems and connected SMEs’ business systems with our cash management platform.
Read more about digitalisation here.
Accelerated recognition of weak oil and gas support services as non-performing removes asset quality overhang
We took the decision to recognise residual weak oil and gas support service exposures as NPA during the year to remove uncertainty about our asset quality and earnings. Of the SGD 5.1 billion of exposures we had to the sector, which accounted for less than 2% of the Group’s overall portfolio, we have conservatively recognised SGD 3.0 billion as non-performing.
We also took a conservative approach to valuing vessel collateral by marking them down to liquidation valuations. This reduced collateral values to SGD 1.5 billion, or half of the NPA. We then took specific allowances during the year to cover the other SGD 1.5 billion of NPA that was uncollateralised.
We were able to partially offset the profit and loss impact of the specific allowances by writing back general allowances. Under Singapore Financial Reporting Standards (International) 9 (SFRS(I) 9), the amount of general allowance reserves we were permitted to maintain on 1 January 2018 was substantially lower than the amounts we had been holding. We wrote back SGD 855 million to bring cumulative general allowances closer to the permitted amount. With the general allowance write-back, net total allowance charges amounted to SGD 1.54 billion for the year, an increase of 8% over 2016.
Balance sheet remains strong
Outside of oil and gas support services sector, asset quality for the rest of the portfolio remained healthy. New NPA formation remained low and specific allowances were at SGD 552 million.
We maintained prudent levels of allowance coverage. The 50% coverage for the oil and gas support services NPA was prudent because of the conservative approach we took for both NPA recognition and collateral valuation. For the rest of the portfolio, allowance coverage was 118%. Our reported overall allowance coverage of 85% was the composite of both portfolios.
We had adequate liquidity to support asset growth. The loan-deposit ratio was comfortable at 86%. Deposits rose 11% or SGD 38 billion to SGD 374 billion, which included SGD 11 billion from the consolidation of ANZ. The liquidity coverage ratio in the fourth quarter of the year was 131%, which was above the final regulatory requirement of 100% due in 2019. Our net stable funding ratio was also above the regulatory requirement effective 2018.
New methodology for allowances
In addition to taking specific allowances for impaired loans, Singapore banks have been required by MAS Notice 612 to maintain general allowances of at least 1% of uncollateralised credit exposures.
From 1 January 2018, SFRS(I) 9 requires banks to classify financial assets into three categories based on their risk profile. For impaired (or Stage 3) assets, we will continue to take specific allowances as before. For unimpaired (or Stage 1 and 2) assets, we will calculate an expected credit loss (ECL) balance. The starting point of the ECL estimate is risk measures from Basel models modified to incorporate point-in-time and forward-looking adjustments. For non-retail portfolios, these are based on current and forecasted credit-risk-cycle indices for significant industries and regions. For retail portfolios, these are based on latest loss experience and macroeconomic forecast models. Changes to the ECL from period to period will then be reflected as allowance charges in the profit and loss account. The Stage 1 and 2 ECL, and hence the allowance charges, are likely to be lower but more volatile than the general allowances we previously took. We will factor the volatility into our capital planning as it affects earnings and ultimately CET1 capital.
While Singapore banks will fully adhere to SFRS(I) 9 standards in their financial reporting from 2018, they will also be required to continue maintaining general allowances of at least 1%. For periods when the Stage 1 and 2 ECL falls below the 1% mark, the shortfall is appropriated from retained earnings in shareholders’ funds into an account called the Regulatory Loss Allowance Reserves (RLAR). Unlike retained earnings, the RLAR is non-distributable and is considered as Tier-2 capital instead of CET1. When the Stage 1 and 2 ECL exceeds the 1% mark, no RLAR is required.
The general allowances we had maintained as at 31 December 2017 were at the 1% mark and amounted to SGD 2.62 billion. The estimated Stage 1 and 2 ECL that was computed as we transited to SFRS(I) 9 standards on 1 January 2018 was lower at SGD 2.53 billion. The difference of SGD 95 million was transferred to shareholders’ funds as RLAR on 1 January 2018.
Read more about SFRS(I) 9 here.
We enter the new year with the region’s economies registering healthy momentum in synchrony with the US and Europe. Our multiple business engines, bolstered by the consolidation of the ANZ businesses we acquired, will enable us to continue capturing growth opportunities in the reflationary environment.
At the same time, we are well-positioned to improve returns. Higher interest rates will boost our net interest margin. Our systematic and pervasive digitalisation efforts will improve the cost-income ratio by raising our productivity in developed markets and by expanding our reach in emerging markets with lower structural costs. With regulatory requirements now clear, our capital buffers that had been built are being returned.
The combination of healthy growth and higher returns will enable us to deliver superior shareholder value in the coming years.
Business momentum increased over course of year
Business momentum accelerated over the course of the year, resulting in a progressive increase in the year-on-year growth of total income and profit before allowances. A large part of the year’s income and operating earnings growth occurred in the second half.
At the same time, the growth in income and operating earnings was due fully to net interest income and fee income. Other non-interest income was lower for each of the four quarters due to a weaker trading performance.
The acceleration in net interest income growth was due to both net interest margin and loans. Net interest margin in the first half was lower than the year-ago period, but stabilised in the third quarter and rose in the fourth. Loan growth had a slow start in the first quarter and progressively accelerated in the subsequent quarters.
Fee income growth was also faster in the second half as both business momentum and buoyant market sentiment boosted a range of fee income activities.
Net interest income
Net interest income increased 7% to SGD 7.79 billion.
Net interest margin declined five basis points to 1.75% as benchmark Singapore-dollar interest rates used for pricing Singapore dollar loans were lower on average. The margin pressure occurred in the first half; compared to the year-ago period, net interest margin was stable in third quarter and higher in the fourth.
Gross loans grew 11% or SGD 33 billion in constant-currency terms to SGD 328 billion, of which SGD 8 billion was from the consolidation of the Singapore, Hong Kong, China and Taiwan businesses acquired from ANZ. The underlying growth of 9% was broad based. Non-trade corporate loans expanded 6%, led by borrowers in Singapore and Greater China, while trade loans rose by 25%. Consumer loans increased 8%, led by Singapore housing loans.
Deposits rose 11% or SGD 38 billion to SGD 374 billion. Savings and current accounts continued to account for the majority of the underlying increase, in line with efforts to grow transactional accounts.
Net fee income increased 12% to SGD 2.62 billion. Wealth management fees rose by an underlying 25% as buoyant markets boosted demand for investment products including unit trusts. Investment banking fees were 14% higher from stronger equity underwriting and fixed income activities. Transaction services fees rose 6% as cash management fees grew. Card fees also rose from higher customer transactions in Singapore and Hong Kong.
Other non-interest income fell 18% to SGD 1.51 billion due to weaker trading income as well as corporate customer treasury income. An increase in net gain on investment securities was partially offset by lower gains on fixed assets.
Business unit and geography performance
By business unit, total income from Consumer Banking/ Wealth Management rose 9% to SGD 4.67 billion. The growth was broad based across loans, deposits, investment products and cards. The Wealth Management customer segment increased 25% to SGD 2.11 billion as assets under management grew 24% to SGD 206 billion, which included SGD 18 billion from the consolidation of ANZ. The acquisition cements DBS’ position as one of the largest wealth management banks in Asia Pacific. Institutional Banking income was little changed at SGD 5.28 billion. Growth in income from cash management was offset by declines in loan-related and treasury customer income. Trading-related income in Treasury Markets fell 24% to SGD 856 million.
By geography, Singapore income increased 3% to SGD 7.80 billion from loan and fee income growth. Hong Kong income grew 6% to SGD 2.22 billion, also from higher loan volumes and fee income. The Rest of Greater China income increased 3% to SGD 855 million as net interest income growth was partially offset by lower trading income. South and Southeast Asia income declined 3% to SGD 696 million from lower loan volumes and trading income, partially offset by a higher net interest margin.
Expenses rose 3% to SGD 5.13 billion as productivity gains from digitalisation and cost management initiatives contained expense growth.
With a greater proportion of transactions and processing taking place digitally, the unit cost of serving customers fell. We redesigned our operations, moving from manual to paperless straight-through operations. This enabled us to handle higher business volumes with fewer resources, improving operating leverage as more of the additional income earned flowed to the bottom line. In addition, the shift away from traditional channels enabled us to reduce structural enterprise-wide overhead costs.
Asset quality and allowances
We took the decision to recognise residual weak exposures in the oil and gas support services sector as NPA during the year to remove uncertainty about asset quality. Three-fifths of our SGD 5.1 billion exposure to the sector have now been classified as NPA.
Asset quality for the rest of our loan portfolio remained benign during the year. NPA formation amounted to SGD 1.0 billion compared to SGD 2.0 billion in the previous year. The NPL rate for the rest of the portfolio was unchanged at 0.9%.
The allowance coverage of 50% for oil and gas support service exposures was prudent given the conservative approach we took in recognising NPAs and valuing collateral. For the rest of the portfolio, the allowance coverage was at 118%.
First bank to develop methodology to measure digital value creation
Banks often tout operating metrics to demonstrate the progress of their digitalisation efforts. However, the impact on earnings is unclear. We believe we are the first bank to have developed a methodology, which has been tested over three years, to measure the financial impact of digitalisation. We intend to provide updates to the financial data annually.
Our profit and loss measurement is for the consumer and SME businesses in Singapore and Hong Kong, where the impact of digitalisation is most clearly visible. The businesses currently account for 44% of the group and could rise to half in five years.
Customers in these businesses are delineated into two segments – digital and traditional – based on how they interact with us. Digital customers are those who have used digital channels to either purchase a product or upgrade to a higher customer segment; or carry out more than half of their financial transactions; or carry out more than half of non-financial transactions over a 12-month period. Those that do not continue to do so revert to being classified as traditional.
Digital customers made up 42% of the total base in 2017 but contributed 63% of income and 72% of profit before allowances. Since 2015, income from these customers has also grown at a compounded annual growth rate (CAGR) of 27% compared to a 4% decline for traditional ones. Digital customers gave us a ROE(5) of 27% in 2017, nine percentage points ahead of the traditional segment.
(5) 2017 ROE adjusted for accelerated provisioning in SME; without adjustments, 2017 ROE is 20% overall, 15% for traditional segment and 23% for digital segment
The drivers of digitalisation’s superior financial metrics There are two reasons for the superior financial metrics of digitalisation. First, the costs of acquiring and serving customers are lower each time digital channels are used. As customers increasingly adopt digital behaviours, we are able to reduce reliance on physical infrastructure such as branches to support customers. This will enable us to optimise enterprise costs over time. All these mean that more of the income earned from customers contributes directly to the bottom line.
Second, digital consumer and SME customers bring twice as much income per head than their traditional peers. This is because digitalisation improves customer engagement, translating into a higher share of wallet. The deeper relationship is broad based across multiple products and has been consistently so over the years.
We also found that when traditional customers adopted digital behaviours, they would become more engaged and transact more with us. This provided corroborating evidence that digitalisation increases the stickiness of customer relationships.
The third chart on the right shows that, in 2017, the income we earned from digital customers and from traditional customers who adopted digital behaviours grew more quickly than the average of the total customer base. By contrast, income growth from customers that stayed traditional was below the average.
Encouraging customers to become digital Our business plans include initiatives to encourage customers to adopt digital behaviours. The growing size of such customers will drive shareholder value creation. Over time, we expect the proportion of digital customers to increase from the current 42% to 50-60%. This will lead to further improvements in the cost-income ratio, which we expect to decline to below 40%. Over time, the cost-income ratio will become a more significant driver of ROE.
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- Record performance underscores quality of customer franchise enhanced by digital transformation
- Capital and dividends
- Broad-based growth in customer franchise
- Digitalisation boosts income and productivity
- Accelerated recognition of weak oil and gas support services as non-performing removes asset quality overhang
- Balance sheet remains strong
- New methodology for allowances
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