Armed with low-cost operating models, three South African digital banks are betting on aggressive pricing and data analytics to attract tech-savvy, price-conscious consumers when they launch next year in a rare challenge to the old guard.

It will be first time the $30 billion industry has faced competition since the early 2000s, when Capitec Bank muscled into a sector dominated by Absa, FirstRand , Nedbank and Standard Bank.

The mobile banking newcomers, Discovery Bank, TymeBank and Bank Zero, all expect to have substantially lower cost-to-income ratios than the big five lenders, giving them scope to disrupt the pricing of retail banking products in South Africa.

"We are here to shake up the status quo. Much the same as Uber did in the taxi industry," Sandile Shabalala, chief executive of TymeBank, a financial technology company controlled by tycoon Patrice Motsepe, told Reuters.

While the newcomers' focus is South Africa, Bank Zero, for one, said it may look at other emerging markets in due course, and investors say because all three have strong IT platforms and use digitalisation, it should be easier to expand.

The challenge in South Africa is to make inroads in a market where over 80 percent of the population already have bank accounts. Elsewhere in Africa, 350 million people have no form of bank account and lenders such as Standard Chartered and Ecobank are testing the waters with digital banks.

With fewer employees, lower administrative expenses and less need for costly back-office technology, the South African challengers hope they can woo customers with fees as low as zero, higher rates on savings and cheaper credit.

While all three declined to put a figure on their expected cost-to-income ratios, four industry executives who spoke on condition of anonymity said they had worked out efficiency ratios of 25 percent to 30 percent.

That compares with nearly 60 percent for the incumbents.

"I have been dumbfounded at how low the cost can be," said Bank Zero's co-founder Michael Jordaan, best known for turning FirstRand's retail banking operation into the most profitable in South Africa. "Our technology cost is 1 percent of 1 percent of the annual tech budget at one of the big banks."

ENTRENCHED RIVALS

Jordaan's comments were largely echoed by senior executives at TymeBank and Discovery Bank, which is part of insurance company Discovery Ltd.

The major banks have taken note.

"There's anxiety in executive committee meetings about what's about to happen," an executive at one of the big banks said. "Your regular bank will be happy with a cost-to-income ratio of 50 percent."

Nevertheless, customers have proved reluctant to switch banks in South Africa in the past. Standard Chartered, for example, tried and failed to take on the big banks in the early 2000s with online lender 20Twenty.

Improvements in technology since and a wider acceptance of online services, however, mean the challengers may have a better chance this time. Similar ventures in markets such as the United Kingdom are slowly making inroads.

More than a million people now use Monzo's current account and money management mobile app while money transfer firm Revolut has 3.2 million customers across Europe - and both have broken through the billion dollar valuation mark.

Still, luring customers away from a deeply entrenched South African banking sector will be a major challenge, and the big banks are unlikely to cede customers without a fight.

South African banks escaped the global financial crisis partly thanks to regulations that stopped them buying the U.S. mortgage-backed assets that triggered the meltdown, as well as a more cautious approach to borrowing.

Headline earnings, the main gauge of profitability, have increased more than two-fold at the big five banks since 2011 to a combined $5 billion.

Their average return on equity, a measure of income generated with shareholders' money, stands at 18.6 percent, nearly double global peers - many of which are already cutting costs as they grapple with digital newcomers.

South African banks have also been cutting jobs, closing branches and encouraging customers to use digital channels as part of their efforts to lower cost-to-income ratios.

"These banks have got established customers on their books right now, so they are going to do the best to retain these customers," said Costa Natsas, partner at auditing firm PwC https://www.pwc.co.za/en.html in South Africa.

FIERCE COMPETITION

Worrying for the incumbents, though, is the fact Capitec's success was based on aggressive pricing. After a slow start, it has more than doubled its client base in the past five years and has an industry-leading return on equity of 27 percent.

According to a survey by consultants McKinsey & Company https://www.mckinsey.com published in February, pricing was the primary reason nearly 60 percent of Capitec's 10 million customers switched.

"While we haven't disclosed yet what our pricing structure will be, the name Bank Zero should give you a very strong hint of what the banking fees should be," Jordaan told Reuters.

"Once we launch, there will be many more things that we think we can do to revolutionise banking, not just in South Africa, but also other emerging markets," he said.

Fees at the main banks for deposits, withdrawals and transfers have for years largely ranged from 100 rand to 250 rand a month, but can rise as high as 450 rand - a sizeable sum in a country where the minimum wage is 20 rand per hour.

"Is the competition going to be fierce? Of course, it's all about the value customers perceive they will get when considering whether to switch banking providers or not, and this will largely determine whether inroads are gradual or accelerated," said PwC's Natsas.

The other battlefield will be in the pricing of credit and interest on savings accounts. With rates now on basic savings accounts ranging from 2.6 percent to 5 percent, traditional banks might have to offer at least double to compete.

"We're paying roughly up to 10 percent interest in our savings account, that's something we've never heard of in this country," said TymeBank CEO Shabalala, who previously worked for Nedbank.

DATA ANALYTICS

TymeBank has said it will launch officially next year, Bank Zero is aiming for early 2019 and Discovery Bank is due to launch in March.

Discovery is pinning its hopes on a data programme called Vitality that helped Discovery Ltd's health insurance business overtake rivals such Liberty Health. Vitality is a behaviour tracking programme that rewards health insurance clients for healthy lifestyles, such as by paying for gym memberships.

"We followed our purpose in making people healthier but in a financial sense," said Adrian Gore, founder and chief executive Discovery Ltd, referring to the new bank's business model.

Discovery Bank will target the group's 2 million health insurance clients, rewarding them with lower rates on loans and higher rates on saving accounts - provided they achieve targets such as saving for retirement, paying down a mortgage or having short-term insurance.

Discovery, which is considering giving 10 percent of the bank to black investors, is not the only one relying on data analytics.

TymeBank, which is majority black-owned, has teamed up with South Africa's second largest supermarket chain Pick n Pay to roll out a money transfer service for the retailer's 10 million loyalty programme clients.

The partnership also gives TymeBank a pool of potential customers to target and would give clients a point of contact at Pick n Pay's more than 700 branches, Shabalala said.

TymeBank is also in advanced talks about joining forces with companies that could provide insurance for customers who take out loans, he said, declining to give further details.

Two sources said TymeBank was seeking partnerships with retirement funds firm Alexander Forbes and insurance giant Sanlam - companies that could provide a pool of potential customers and data.

Sanlam told Reuters it would team up with a bank if the alliance supported its strategy and was mutually beneficial. "Any potential opportunities to collaborate with Tyme would be evaluated accordingly," Sanlam said.

Alexander Forbes did not respond to requests for comment.