Global Bank­ing Re­view .............................

The McKin­sey Global Bank­ing An­nual Re­view 2019, which came out re­cently, cau­tions that bank­ing in­dus­try is at crossroads and those want­ing to sur­vive need to take ex­treme re­me­dial mea­sures:

Banking Frontiers - - Contents - mo [email protected] bank­ing fron­tiers, com

Bank­ing in­dus­try to­day is see­ing a slow­ing down in top-line rev­enues with loan growth of just 4% in 2018, which is the low­est in the past 5 years and 150 ba­sis points be­low nom­i­nal GDP growth, finds McKin­sey Global Bank­ing An­nual Re­view 2019 ti­tled ‘ The last pit stop? Time for bold late-cy­cle moves’.

The re­view cau­tions that yield curves are flat­ten­ing and though val­u­a­tions fluc­tu­ate, in­vestor con­fi­dence in banks is weak­en­ing.

It points out that global re­turn on tan­gi­ble eq­uity (ROTE) in the case of banks has flat­lined at 10.5%, de­spite a small rise in rates in 2018. “Emerg­ing mar­ket banks have seen ROTEs de­cline steeply, from 20% in 2013 to 14.1% in 2018, due largely to dig­i­tal dis­rup­tion that con­tin­ues un­abated. Banks in de­vel­oped mar­kets have strength­ened pro­duc­tiv­ity and man­aged risk costs, lift­ing ROTE from 6.8% to 8.9%. But on bal­ance, the global in­dus­try ap­proaches the end of the cy­cle in less than ideal health with nearly 60% of banks print­ing re­turns be­low the cost of eq­uity. A pro­longed eco­nomic slow­down with l ow or even neg­a­tive in­ter­est rates could wreak fur­ther havoc,” says the study.


Joy­deep Sen­gupta, co-au­thor of the re­view and Sin­ga­pore-based McKin­sey se­nior part­ner says: “His­tory tells us that 40% of the top banks to­day will drop to the bot­tom half of peers in the next cy­cle. So the time for bold and crit­i­cal moves is now. Moves made to­day, be it to build scale or re­struc­ture busi­ness mod­els, will have a defin­ing role in com­bat­ing the prob­a­bil­ity of that slide.”

High­light­ing that ad­vanced an­a­lyt­ics and ar­ti­fi­cial in­tel­li­gence are al­ready pro­duc­ing new and highly ef­fec­tive risk tools, the study ad­vo­cates banks should adopt them and build new ones. It fur­ther adds: “On pro­duc­tiv­ity, mar­ginal cost-re­duc­tion pro­grams have started to lose steam. The need of the hour is to in­dus­tri­al­ize tasks that don’t con­vey a com­pet­i­tive ad­van­tage and trans­fer them to multi-ten­ant util­i­ties. In­dus­tri­al­iz­ing reg­u­la­tory and com­pli­ance ac­tiv­i­ties alone could lift ROTE by 60 to 100 bps. Fi­nally, on gen­er­at­ing elu­sive rev­enue growth, now is the time to pick a few ar­eas - client seg­ments or prod­ucts - and rapidly re­al­lo­cate top cus­tomer-ex­pe­ri­ence tal­ent to at­tack the most valu­able ar­eas of growth and take share as com­peti­tors with­draw and cus­tomer churn in­creases late in the cy­cle.


The study men­tions 2 vec­tors for ev­ery bank - the strength of its fran­chise and the con­straints of its mar­kets or busi­ness model. It then adds: “Us­ing these two vec­tors, we’ve iden­ti­fied 4 archetypes that banks around the world can use to iden­tify their start­ing po­si­tions and de­velop their late-cy­cle pri­or­i­ties.”

These 4 are:

Mar­ket lead­ers: 20% of banks glob­ally cap­ture al­most 100% of the eco­nomic value added by the en­tire in­dus­try. These at-scale banks typ­i­cally serve a large share of a ge­og­ra­phy, re­gion, or cus­tomer seg­ment and op­er­ate in fa­vor­able mar­ket con­di­tions. Their clear­est im­per­a­tive is to rein­vest cap­i­tal and re­sources in­tel­li­gently in in­no­va­tion and fur­ther scale for the next cy­cle.

Re­silients: Nearly 25% of banks have main­tained lead­er­ship in chal­leng­ing mar­kets, in­clud­ing many i n Europe. Re­silients should fo­cus on ex­pand­ing be­yond their di­rect set of cus­tomers and prod­ucts through ecosys­tem plays and dif­fer­en­ti­at­ing fur­ther through in­no­va­tion.

Fol­low­ers: About 20% of banks have not achieved scale, and are weaker than peers, de­spite fa­vor­able mar­ket dy­nam­ics. They are at risk from a down­turn and must act promptly to build scale in their cur­rent busi­nesses, shift busi­ness mod­els to dif­fer­en­ti­ate, and rad­i­cally cut costs.

Chal­lenged banks: About 35% of banks glob­ally are both sub-scale and

suf­fer from op­er­at­ing i n un­fa­vor­able mar­kets. Their busi­ness mod­els are flawed, and the sense of ur­gency is acute. To sur­vive a down­turn, merg­ing with sim­i­lar banks or sell­ing to a stronger buyer with a com­ple­men­tary foot­print may be the only op­tions if rein­ven­tion is not fea­si­ble.


The study says: “Glob­ally, on­line bank­ing us­age rates in­creased on av­er­age by 13 per­cent­age points from 2013 to 2018, and there is room for fur­ther growth across all ge­ogra­phies, par­tic­u­larly as con­sumers’ will­ing­ness to trans­act over dig­i­tal chan­nels ex­ceeds ac­tual dig­i­tal us­age by more than 30 per­cent­age points in many mar­kets. Con­sumers have be­come ac­cus­tomed to real-time and per­son­al­ized ser­vices and ex­pect the same of dig­i­tal bank­ing so­lu­tions. While this be­hav­ior is most acutely felt in re­tail bank­ing and as­set man­age­ment, we are start­ing to see the same trends emerge in cor­po­rate bank­ing as well as in cap­i­tal mar­kets and in­vest­ment bank­ing. A clas­sic ex­am­ple is a trend within trans­ac­tion bank­ing where clients in­creas­ingly de­mand a sin­gle win­dow and real-time multi-cur­rency multi-as­set view of a firm’s pay­ments po­si­tions with re­duced set­tle­ment times with each pass­ing year. They also ex­pect bank­ing ser­vices to be in­creas­ingly linked into their in­ter­nal fi­nance and trea­sury func­tions. Within re­tail bank­ing, where cus­tomer loy­alty has tra­di­tion­ally been strong, rates of cus­tomer at­tri­tion are ris­ing, as dig­i­tal tech­nol­ogy and chang­ing reg­u­la­tions make it rel­a­tively pain­less for cus­tomers to change banks. For in­stance, churn rates for cur­rent ac­counts in the US have risen from 4.2% in 2013 to 5.5% in 2017 and in France they have risen from 2% in 2013 to 4.5% in 2017.”


The study says the rapid dis­rup­tion of Asia’s bank­ing sec­tor is marked by a swift rise in com­pe­ti­tion from fin­techs and dig­i­tal plat­form com­pa­nies contributi­ng to a sharp de­te­ri­o­ra­tion of more than 600 bps in ROTE over the past 5 years. De­vel­oped mar­ket banks, wary of the Asian sce­nario play­ing out in their home mar­kets, dream of an end to this fin­tech cy­cle, it says, adding, how­ever, peo­ple’s per­cep­tion of trust to­wards fin­techs and tech com­pa­nies con­tin­ues to im­prove.


The study de­votes sec­tion to dis­cuss the scale of im­pact by ge­og­ra­phy and states in-coun­try scale is a sig­nif­i­cant fac­tor in gen­er­at­ing higher ROTEs, but the im­pact of scale varies in mag­ni­tude across ge­ogra­phies. To un­der­stand this vari­ance, the study an­a­lyzed the re­la­tion­ship be­tween C/A ra­tio and in-coun­try mar­ket share for banks world­wide and finds that larger banks are gen­er­ally more cost-ef­fi­cient. Some of the ex­am­ples are:

Dig­i­tal ad­vanced mar­kets: These in­clude mar­kets like Aus­tralia, Swe­den and Den­mark, where bank­ing is rapidly mov­ing on­line and where the scale im­pact is pro­nounced. In Swe­den, the top 3 banks by mar­ket share have a C/A ra­tio of ap­prox­i­mately 77 ba­sis points, while the C/A ra­tio of the bot­tom quin­tile ex­ceeds 340 bps. This gap points to the in­creas­ingly trans­for­ma­tive i mpact of tech­nol­ogy on bank­ing.

Highly frag­mented mar­kets: These in­clude mar­kets like Rus­sia, Ger­many, and the US, where de­spite highly frag­mented mar­kets, there are strik­ingly dif­fer­ent im­pacts of scale. In Rus­sia, de­spite the cen­tral bank’s ef­forts, its bank­ing sys­tem is still highly frag­mented, with more than 500 banks. At 200 bps, the av­er­age C/A ra­tio for the top three banks is less than a half that of the low­est quin­tile (430 bps). By con­trast, in the US, an­other highly frag­mented mar­ket, the gap be­tween the bot­tom quar­tile and top three is only 71 bps.

Emerg­ing Asian mar­kets: In China and In­dia, cost ef­fi­ciency is as­so­ci­ated with scale, but to a very dif­fer­ent ex­tent. In

China’s bank­ing sec­tor, which is dom­i­nated by many cor­po­rate banks hold­ing large bal­ance sheets, the av­er­age C/A ra­tio for the top 3 banks by mar­ket share is 84 bps, which is half that of the av­er­age for the low­est quin­tile (169 bps). In In­dia, by con­trast, while some scale ef­fect is vis­i­ble, even the largest banks have a C/A ra­tio higher than 200 bps. In­dian banks typ­i­cally have a higher cost base, in part be­cause many main­tain large phys­i­cal net­works to serve ru­ral cus­tomers.


The re­port states that given the com­pet­i­tive ad­van­tages that come with scale, many banks are find­ing that merg­ers and ac­qui­si­tions - along with strate­gic part­ner­ships - are an ef­fi­cient way to achieve their scale am­bi­tions or a means to com­pletely rein­vent their busi­ness mod­els. “In­deed, the ground for merg­ers, ac­qui­si­tions, and part­ner­ships is fer­tile, as the cur­rent en­vi­ron­ment pro­vides a fa­vor­able com­bi­na­tion of cap­i­tal, reg­u­la­tion, and se­nior-level in­ter­est. First, there is a large dis­per­sion in val­u­a­tions and cap­i­tal lev­els across the bank­ing sys­tem, cre­at­ing an ideal en­vi­ron­ment for in­or­ganic moves. Sec­ond, with sys­temic risk in bank­ing largely mit­i­gated through cap­i­tal and liq­uid­ity build-ups since the global fi­nan­cial cri­sis, and frag­mented bank­ing sec­tors in many mar­kets strug­gling to pro­duce re­turns, reg­u­la­tors are more likely to be sup­port­ive of con­sol­i­da­tion. Third, the need for largescale in­vest­ments in tech­no­log­i­cal trans­for­ma­tion, com­bined with weak or­ganic growth, is push­ing M&A up on the board agenda. Banks, how­ever, should be care­ful as they as­sess these op­tions, as very few deals have his­tor­i­cally cre­ated value,” it says.

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