S&P Global Ratings believes that Nordic banks are in a good position to ward off digital disruptors. Adaptation to a rapidly changing financial ecosystem started already two decades ago and digital capabilities and strategies were boosted accordingly.

Applying our four-factor TRIP (technology, regulation, industry, preferences) illustration analysis reveals that customer preferences as well as a strong Nordic fintech industry are forcing incumbent banks to adapt their products and services. We understand that so far, their approach has been three-fold:

• First of all, big Nordic banks are digital pioneers compared with many of their European peers. They are streamlined and started to digitize their product portfolio early on, especially in the online banking and mobile payment sector. So far, this has helped the incumbent banks protect their business model and defend their strong market positions and revenues.
• Secondly, cooperation among larger banks in an already highly concentrated banking market is giving them an advantage over smaller competitors trying to expand market share. However, the latter are successful in entering niche segments such as consumer loans or certain segments of mortgage lending.
• Finally, Nordic banks have actively embraced cooperation with fintechs. Thus, fintechs might act as a vector of business opportunities rather than a disruptive threat.

However, keeping up pace with the speed of innovation will remain important. Nordic citizens are digitally savvy and might easily switch to other financial services providers if banks are not responding to their new needs. So far, the regulatory framework neither supports nor discourages fintechs, but remains a barrier to entry, given strict banking licensing requirements.

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Industry: Disruption Risk – Low

Nordic banks are digital frontrunners, using cooperation with peers and in-house solutions to ward off disrupters

One of the most distinguishing features of the Nordic financial sector, that serves about 27 million inhabitants across the region, is its high degree of concentration and interconnectivity. Pan-Nordic banks have been known to primarily focus on their region and the banking market is dominated by eight large groups alongside a number of small institutions that usually operate exclusively in their home country. The top three Nordic players in terms of bank assets are Nordea Bank, Danske Bank, and Svenska Handelsbanken. However, despite each market being rather concentrated, the ultimate market leaders vary from country to country.

In Norway, DNB Bank dominates the market, ahead of pan-Nordic banks (e.g. Nordea) and domestic savings banks alliances. Nordea is also one of the most active banks in Denmark, alongside domestic players Danske Bank, Nykredit, and Jyske Bank. In Finland, the market is dominated by OP Financial Group, followed by Nordea Bank and Danske Bank. Iceland's banking landscape slightly differs from the other Nordic countries, given that the three domestic commercial banks (namely Arion bank, Landsbankinn, and Islandsbanki) dominate the market with a similar size, although competition from pension funds has further increased recently on residential mortgages.

We consider this high degree of concentration in the Nordic banking sector to be an advantage for the incumbent retail banks as it represents a significant challenge for digital disruptors trying to enter the market.

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National banking sectors within the Nordic region are tightly interconnected and most of the large Nordic banks operate cross-border, adding positive scale effects. Hence, Nordic banks' branches continue to dominate the market. This long tradition of cross-border banking can be explained, among other factors, by low cultural barriers, early-on cross-border mergers, and similar market conditions.

Over the past several years, cross-border cooperation has further increased. An example is the recent P27 Nordic Payments Platform, a joint project of Danske Bank, Handelsbanken, Nordea, OP Financial Group, SEB, and Swedbank. P27 aims at establishing a single pan-Nordic payment infrastructure serving 27 million customers. Once finalized in 2021 it will represent the world's first real-time cross-border payment system in multiple currencies ultimately possibly replacing national payment systems based on aging technology. We believe that P27 will further help to consolidate the strong position of the Nordic financial banking sector in payments. Thus, it could act as an effective instrument to protect the industry from disruption by Big Tech and other non-bank players.

Another example of successful cooperation among banks can be found in the Finnish mortgage and real estate market, which could be transformed over the coming years using distributed ledger technology. A consortium of banks (Aktia, Danske Bank, Nordea, OP, and S-Bank), together with other private and public sector players, developed DIAS, a digital trading platform for residential real estate based on blockchain technology. DIAS brings all agents involved in the property transfer and mortgage process together and thus drastically simplifies the formerly lengthy and manual process of property sales. The first digital home sale was in December 2018, but large scale application will require digitalization of the land registry. Again, we consider this inter-bank cooperation to be a strength for the Nordic retail banking market, as new digital solutions are being developed before challengers can disrupt markets that were traditionally dominated by banks.

Furthermore, strong profitability and solid capital adequacy are additional strengths of the Nordic banking sector, allowing these banks to continuously invest in innovation and automation. Nordic banks are on average better capitalized than banks in Western Europe. S&P Global Ratings' risk-adjusted capital ratio (RAC, our measure of capital adequacy) remains high among Nordic banks, at an average of 12% at year-end 2018, higher than the average 10% RAC ratio for the top 50 rated Western European banks. Nordic banks also continuously outperform their European peers in terms of profitability and cost-efficiency. Average return on common equity for Nordic banks was 10.4% in 2018, which is significantly higher than the average for the top 50 European banks of 7.4%. The cost-to-income ratio in the Nordics is 53.7%, as opposed to an EU average of 57.6%. The Nordics also provide a stable operating environment, which is advantageous for retail banks. Nordic banks use their current strong profitability to further invest in IT infrastructure, which we consider already materially better than that of many European peers.

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Moreover, we consider Nordic banks to be extremely well equipped to cope with the challenges arising with technological advancements. Many of them were pioneers with regard to embracing new technologies and have fostered the development of financial services IT for decades. Although there are differences between countries, most initial hurdles, such as electronic identification infrastructure, have been well established in the Nordics for over 15 years. However, it is important to note that there are significant differences between the national champions and smaller players, with the latter having progressed far less and being less adaptive with regard to technological innovations.

The high penetration of digital services, along with an urbanization trend, has pushed banks to wind down branches early on and move much of their traditional banking services online. Projections for 2030 suggest that the process of urbanization will continue, and regions around Copenhagen/Malmö, Stockholm, Oslo, and Helsinki will grow significantly. Nordic banks provide a good example of successful cost optimization through digitalization and automation. The branches that still exist will focus on advice rather than basic payment services.

However, we note that at the same time, technological innovation in financial services has heightened competition from non-banks. Over the past decade, Nordic banks have been facing a rapidly changing market that has been shaken up by digital newcomers and their customer-focused business models. We understand that the general approach to tackling this challenge has been fairly similar across big banks in the Nordics. A prominent strategy chosen by Nordic banks consists of actively embracing collaboration and partnership with fintechs, a good way to internalize knowledge for example in the accelerator model (for example, Nordea Startup Accelerator, OP Lab, DNB NXT Accelerator, or Copenhagen FinTech Accelerator). This approach has proven to be more cost-effective and faster than developing in-house solutions and we believe that Nordic retail banks will continue to follow a collaborative strategy with fintechs since these partnerships enable them to stay relevant, offer leading innovations, and generate new revenue in a rapidly evolving industry. However, we understand that it is still a challenge to find the best partnership structure between traditional banks and fintech newcomers. A gold standard has not been established yet.

There are numerous examples of cooperation: In 2018, Danske Bank became co-owner of a fintech company for the first time by investing DKK10 million in Danish fintech, Spiir. Spiir served as a foundation to build the Nordic API Gateway, a platform that collects data from all Nordic banks in one place. DNB and Danske Bank are both investors in the Nordic API Gateway. Both Danske Bank and Swedbank have entered an agreement with Swedish company Minna Technologies providing customers with subscription management tools/platform. SEB and Nordea have both invested in Tink, a Swedish company providing aggregation services originally as a consumer-facing finance app that has subsequently developed into an open banking platform. In cooperation with the technology incubator StartupLab, DNB created DNB NXT Accelerator, one of the leading fintech accelerators in Norway. Also, DNB has been cooperating with leading universities and research institutions as well as with leading market players from non-financial sectors to create advanced client solutions via venture investments in companies such as Payr, Spiir, FundingPartner. Moreover, almost all banks have established their own fintech startup funds and innovation labs. We note that Nordic banks' significant capital reserves might prove advantageous as promising fintechs can be acquired after a successful partnership phase. Cooperation allows banks to test and choose the best/most suitable solutions and integrate them in their own value chain, thereby remaining relevant for the customers. Hence, smaller fintechs might be seen as vectors of business opportunities rather than disruptive threats.

The second strategy adopted by Nordic banks to ward off competition by digital challengers consists of investment in in-house digital capabilities. Various banks, for example Nordea, Swedbank, DNB, and OP, have invested heavily in artificial intelligence (AI) and in-house developers. This push can also be explained by the fact that cooperation with (and investments in) non-captive fintechs has not always been easy due to a clash of cultures and goals; internally replicating ideas therefore proved to be easier. By creating their own new digital services, banks have been trying to defend their position in the payment market. One key element that sets Nordic payment solutions apart from projects elsewhere is that they are driven collaboratively by the banks, rather than by third-party providers or as one bank's proprietary offering. Three mobile payment applications have experienced extraordinary success and have helped banks to withstand pressure from fintech firms:

• MobilePay in Denmark developed by Danske Bank in partnership with Nykredit has become the most downloaded Danish app. However, it is not restricted to customers of Danske Bank.
• Vipps in Norway, with DNB being its majority owner, has become Norway's largest payment application and is open for customers from any Norwegian bank.
• Swish in Sweden was launched in 2012 by six Swedish banks and is used by over half the population in Sweden.

Finland seems to be the only Nordic country that is slightly deviating, since its mobile payment market is more fragmented, with Siirto, Pivo, and MobilePay, but without a clear market leader. In Iceland, Kass was the first digital wallet platform offered by Islandsbanki.

Together Vipps, Swish, and MobilePay have respective adoption rates of 78%, 75%, and 81% in each of their markets; YouGov's 2019 BrandIndex ranks the apps among the top three brands in Sweden, Norway, and Denmark, respectively. With about 13 million users, their success story in peer-to-peer payments is unique in Europe and has made possible an expansion into other, more profitable areas such as in-store payments, e-commerce, business e-invoicing. This also helps to overcome the challenge of monetizing the apps. Successful consolidation of the various parts of the new financial landscape remains another obstacle over the medium to long term and is already addressed by P27. Promoting broader collaboration between banks and wallets is also one driver behind the European Mobile Payment Systems Association (EMPSA), which was launched last year by Swish, Vipps, and MobilePay, together with four other European payment applications, with the aim to enable the use of mobile payments systems internationally and thus create a rival to Big Tech solutions such as Apple Pay, Google Pay, and PayPal.

Although the payment solutions offered by local banks are very advanced in the Nordics, also benefiting from established banking networks, we observe that competition from Big Tech has been intensifying recently. Over the past two years, Big Tech payment solutions, such as Apple Pay and Google Pay, were introduced to all Nordic markets. Nordic banks are increasingly cooperating with these global players by incorporating their payments solutions in their product portfolio, thus building a second leg while keeping ownership of the customer relationship. Denmark has had the largest uptake of Apple Pay, with 67 banks supporting the application, compared with 12 banks in Norway and 11 in Sweden. We expect Big Tech to increasingly challenge local Nordic brands, especially as these companies have the economic power to revolutionize markets (see: How Much Of A Threat Are Tech Titans To Global Banks?, published Jan. 15, 2018).

The EU Directive PSD2--which opens payment and account services to competitors--became effective in September 2019. Tink, Nordic API Gateway, and Minna Technologies are all examples of Nordic banks entering the open banking ecosystem to create innovative customer solutions. Open banking (giving third-parties access to banking data) is widely perceived to be the next revolutionary force in the banking industry after online banking.

Overall, we understand that so far, innovation by and cooperation among Nordic banks has been shutting out disruptors. As Nordic banks launched their own, national mobile payments system early on, they benefitted from a first mover advantage within the payments sector which has kept most challengers at bay in the area of consumer e-payments. The setup of national and regional incubators has also spurred growth and development. As a result, newer entrants have emerged in complimentary niches to provide additional and plug-on services to banks. While we currently do not consider these new entrants as a threat, some of them could, over time, grow to a size where they may pose a threat to established players.

Technology: Disruption Risk - High

The Nordics: A fintech powerhouse that makes mobile banking easy

In the 1990s, the Nordic countries were at the forefront of the telecommunications industry and since then, their ambition to be leaders in new technologies has not ceased. On the EU's Digital Economy and Society Index (DESI), the Nordics have repeatedly scored higher than the European average, demonstrating their strong digital technology usage and performance.

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Moreover, policy objectives regarding rapid progress toward a more digital economy and society are ambitious in the Nordics. All countries show high degrees of mobile broadband penetration. Within the connectivity dimension of DESI, which looks at both the demand and supply side of fixed and mobile broadband, Denmark has the highest score among all EU countries. Moreover, Sweden and Finland are frontrunners in adopting the new EU broadband targets for 2025 and have also published national 5G roadmaps. Both are among the 10 countries with the fastest internet speed worldwide.

Hence, Nordic digital infrastructure provides a more than solid basis for future developments in financial technologies. We believe that Nordic banks will be in a good position to deliver future products and services that are based on a higher network capacity and speed.

Nordic countries are also some of the most innovative nations. The Global Innovation Index 2019 ranks all Nordic countries among the 20 most innovative countries worldwide. Thus, it is no surprise that the region has become a leading European fintech powerhouse. Hundreds of companies are operating in various subsectors of the banking technology industry such as payments, challenger banks, blockchain technologies, and personal financial management.

The region has produced some of Europe's most valuable fintech unicorns (companies valued at $1 billion or more). Sweden was a pioneer as a flourishing technology start-up scene that started developing already in the early 2000s. Most of the Swedish fintechs are in the payments sectors. The most prominent examples is Klarna, which was valued at $5.5 billion in August 2019 and has thus grown to become one of the most valuable fintechs in Europe. The other Nordic countries followed with a little delay but have also been fairly successful in developing their own hubs and niches for providing financial services. Many Danish fintechs focus on crowdlending platforms, blockchain, and cryptocurrencies. Companies such as coinify or WeMoveCoins have been increasingly active in promoting the use of blockchain technologies. Finland, meanwhile, has specialized in SME financing and e-invoicing with Zervant and challenger bank Holvi. Other Finnish fintechs are taking one step further in the alternative financing arena by providing crowdfunding platforms. Norwegian fintechs, in contrast, can be found in the tech engineering field and start-ups have increasingly focused on authentication (cards, biometrics, identity) and cyber security challenges that arise with an increase in internet-based financial services. An example is Zwipe, which focuses on biometric authentication and security and developed fingerprint identification technology for credit cards while protecting the user's personal information.

We also note that the Nordic banking sector is aware of other challenges in the field of cyber security that are arising with an increasingly digital financial services industry. The Nordic banks are also active in enhancing cyber security cooperatively. In 2017, Nordic financial institutions launched the association Nordic Financial CERT (Computer Emergency Response Team). Its goal is to jointly work toward fast and efficient responses to cyber security threats and online crime.

We understand that although the technology framework in the Nordics is very well established, it will remain a challenge to connect the various disparate component parts of the current ecosystem. Moreover, we believe that further changes in the mobile payment landscape are to be expected over the next couple of years. With the rise of the Internet of Things (IoT), more and more devices will go online and might be able to effect payments autonomously.

We expect the Nordics to most actively pursue a strategy to fully digitalize the underwriting of mortgages. In our view, this will be a critical tool to prevent a massive disruption in a core retail product. As already mentioned above, some of the Nordic countries are very advanced with regard to using distributed ledger technology in the mortgage industry. Sweden and Finland are European pioneers in using blockchain for property transactions. This development has the potential to disrupt the house purchase process and mortgage market as the time lapse between the signing of a purchase contract and the official registering could be reduced to a few hours. The Swedish land registry agency Lantmäteriet has been experimenting with blockchain to record property transactions since 2016 and has partnered with various companies (e.g. blockchain technology company ChromaWay). However, there are still some obstacles that need to be overcome. Currently, Swedish law does not accept digital signatures to register a property sale or purchase.

Preferences: Disruption Risk- High

Cash is no longer king and offering digital solutions is crucial

Client preferences in the Nordics are a key disruption risk for banks and are forcing them to digitalize even further. In our view, large Nordic banks are in a good position to meet expectations of increasingly digitally savvy customers. They have been actively following new trends and continuously modified their product and services portfolio accordingly, e.g. by offering more convenient solutions to manage payments and personal finances. This strategy is crucial as the Nordic region has always been technology-driven. Nordic citizens boast a high level of digital readiness and are extremely willing to adopt new financial technologies tailored to their everyday financial needs.

Given this general openness toward new financial technologies, it is no surprise that Nordic countries have emerged as leaders in the race toward cashless societies. The Nordics have experienced a strong decline in the use of cash infrastructure, especially Norway and Sweden, where cash as a share of means of payments fell to 2.0%. The number of cash payments as a percentage of total payments fell to 9% in Norway in 2019. The Nordics' preference for paying cashless is reflected in the number of card payments per capita. Denmark, for example, had about 364 card transactions per capita per year in 2018, compared with a euro area average of 121. While cards remain by far the most prominent payment instruments, mobile payments have become increasingly popular. Finland is a bit of an outlier, as the use of cash is still fairly popular.

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Another key hallmark of Nordic societies is the ubiquitous digitalization and transparency of the public sector. Some Nordic countries stand out as leading the way in e-government. According to the 2019 United Nations e-government survey, Denmark is the world's best in e-government initiatives. Danish citizens use digital IDs ("NemID") to interact with the government, as well as certain private sector actors. Moreover, a fair amount of personal data is publicly available in the Nordics, which is a crucial difference with most other European countries. Tax returns and information on people's income are usually easily accessible. The practice of public disclosure dates back to the 18th and 19th century. As a result of this tradition of publicly available information, the general public in the Nordics is also far less concerned about data privacy issues than their Europeans peers.

Regulation: Disruption Risk – Moderate

Regulators are increasingly paying attention to digital newcomers

We currently consider the regulatory framework in the Nordics to be a neutral factor in terms of promoting innovation or disrupting retail banking. Most likely, regulators will not foster disruption in the Nordics but rather ensure that the regulation does not hinder competition. Financial services in the region remain generally a heavily regulated sector, mostly targeted at traditional financial business models.

So far, current regulatory frameworks do not seem to be overly ambitious in terms of accommodating specific needs of digital challengers or lowering the bar for banking licenses. Overall, regulators are rather slow to adapt to new challenges arising with fintech, such as cryptocurrencies, blockchain, or AI. Moreover, strict licensing requirements present a challenge for fintech across the Nordics as the process is long and extremely costly. However, current Europe-wide projects might be setting the standards.

Nonetheless, across the Nordics, regulators have established fintech hubs and/or helpdesks to accompany and support new players with regulatory challenges. The Finnish Financial Supervisory Authority has launched an Innovation Help Desk to advise on authorization, registration, and licensing issues--similar to the Swedish FSA's innovation center. The Danish government has launched various support schemes and the Danish FSA has created a fintech team dedicated to minimizing regulatory uncertainties. However there is no specific Fintech legislation or light licenses granted to these players.

Denmark is slightly ahead of its Nordic peers as its FSA launched an experimental sandbox called "FT Lab" in 2018, which provides a safe testing environment for new business models in collaboration with the FSA. Only five companies can participate simultaneously and they are still subject to the applicable legislation. The Norwegian regulator is currently also working on the establishment of a regulatory sandbox with the goal to boost fintech innovation and provide an insight into specific challenges faced by the developing industry. While a sandbox is currently not in place in Iceland, the Icelandic government's White Paper on the Future of Iceland's Financial System suggests it as one measure to deal with fintech innovation. However, changes to the current regulatory framework would be required.

Norway's and Sweden's Central Banks have been considering developing their own digital central bank currency as a supplement to cash. As this effort raises complex challenges, it remains to be seen if this is a viable option in the near future that will promote a secure and effective payment system.

We believe that these regulatory barriers lower the disruptive threat to the retail banking sector as it is harder for smaller companies to compete against well-established players.

Nordic Bank Ratings Remain Strong And Early Investments In Technology As Well As Strategic Cooperation Are Bearing Fruit

Our credit ratings on Nordic banks remain strong in a global comparison, which reflects robust capital adequacy and sound profitability, as well as solid operating conditions and economic strength.

So far, we do not see tech disruption as an existential threat to the Nordic banking sector in the medium-term. In contrast, the industry has been outperforming many of its European peers with regard to new products, innovation, and adjusted business models. This is also an essential response to digitally savvy, demanding Nordic customers, who switch rather quickly to new providers of more tech-focused banking services. In addition to that, the Nordics are one of the leading fintech hotspots in Europe which increases competition and pushes banks to move more rapidly toward a more digital world. However, the past years have revealed that banks increasingly cooperate with fintechs by embedding their services into their customer offer or acquiring them. Moreover, the current industry structure in the Nordics provides banks with another layer of protection as a high concentration and inter-bank cooperation makes it harder for digital challengers to enter the market. Considering these factors, we believe that incumbent banks will be able to maintain solid business positions in the years to come.

Having said that, we note that the Nordics are not completely immune to risks emerging from tech disruption. Continuous investment in new technologies and an adaptation of the product portfolio and business strategies will be required to survive in a rapidly changing financial ecosystem. Banks should improve their data pooling, also against the background of enhancing "know your customer" (KYC) identity verification processes. The Nordic KYC Utility AB – a new joint venture between large Nordic incumbents – is a step in this direction and could possibly be expanded to retail customers in future. While solutions offered by Big Tech far from dominate the market, this might change over the long term, especially as these companies have the economic power to revolutionize markets. We believe that in the medium to long term, the retail banking market will no longer exist in its current form but we believe that Nordic banks are on track to adapt, if digitization efforts continue.

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