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 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.
TIME FOR BOLD MOVES
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.
ONLINE BANKING GROWTH
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.”
COMPETITION FROM FINTECHS
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.
M&A AN OPTION
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.