McKinsey & Company has recently published its Global Banking Annual Review entitled “The Last Pit Stop? Time for Bold Late Cycle Moves.” The document is an examination of the global banking industry, based on a survey of over 1,000 banks globally.
McKinsey suggests the banking industry is approaching the end of the current economic cycle in less than ideal health. Nearly 60 percent of banks are not generating the cost of capital/trading below book and “destroy value.” Yield curves are also flattening. Investor confidence in banks is weakening once again. The digital disruption of the entire industry continues unabated.
The economic situation is likely to worsen in the coming period, banks globally are approaching the last likely pitstop in this economic cycle to rapidly reinvent business models and scale up inorganically.
“Given where many players in the banking industry are today, a serious downturn could be catastrophic for many. This is a ‘do or die’ moment. Whilst imaginative institutions are likely to come out leaders in the next cycle, others risk becoming footnotes to history.”
The report identifies four distinct archetypes, which banks around the world would broadly associate with based on the strength of the individual franchise and the constraints of its markets or business model: ‘market leaders’, ‘resilients’, ‘followers’ and ‘the challenged’.
Fintech is playing a growing role in the development of banks as well as its destruction. McKinsey states that “…most banks have not made the material improvements in productivity needed to compete effectively with Fintechs.”
Some key points from the Review:
The new consumer
“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 (Exhibit 4). Consumers have become accustomed to real-time and personalized services and expect the same of digital banking solutions.”
New standards for propositions
“The rise in customer churn rates results not only from changes in customer expectations but also from the superior levels of service offered by new entrants. These new entrants have also benefited from regulatory changes which have lowered barriers to entry, as well as the continued inflow of capital from investors willing to bet on challengers taking a large share of the profit pool traditionally captured by incumbents. These innovative disruptors have been able to offer customercentric propositions that better meet customers’ needs with engaging and intuitive user interfaces, which, in some cases, can connect to other platforms and become part of a broader ecosystem. All the while, bringing pricing down with increasing transparency for the end consumer.”
A supportive regulatory environment for competition
“Regulators in diverse markets are also contributing to disruption in banking, especially as they take steps aimed at increasing transparency and boosting competition by lowering barriers to entry. Among the most disruptive of these initiatives are moves to open access to customer financial data (on consent) to non-bank service providers. These have been a significant catalyst for new competition from technologyoriented entrants. Open banking, one of the most prominent regulatory developments affecting innovation and competition in the banking sector, is at varying stages of adoption in 35 markets (Exhibit 5), relating to products that account for approximately 90 percent of revenue pools in those markets.”
Platform and fintech disruption at pace
“People’s perception of trust towards fintechs and tech companies continues to improve. For example, McKinsey’s Future of Banking July 2019 Consumer Survey found that most respondents trust big tech companies to handle their financial needs, including Amazon (65 percent) and Google (58 percent). With this backdrop, it is no surprise that investments in the fintech space grew by 29 percent3 in 2018, on the heels of 46 percent annual growth since 2014.
In developed markets, large technology platform companies have made notable forays into the financial services market. Examples are plenty—from Apple’s launch of Apple Card (a credit card albeit issued by a bank) to Facebook’s launch of Calibra as a wallet for its proposed cryptocurrency Libra, as well as Amazon’s venture into small and medium size enterprise (SME) lending. Exacerbating the situation, fintechs and big tech players are attacking the highest ROTE segments of banking, representing approximately 45 percent of the global banking revenue pool. This will put additional downward pressure on banking ROTEs and cash generation at a time when cash is needed most.”
The budget challenge to fund innovation and change
The budget challenge to fund innovation and change The biggest challenge at present for traditional banks is the need to invest in overhauling operating models to compete head-to-head with digital innovators. Both banks and fintechs today spend approximately seven percent of their revenues on IT; but while fintechs devote more than 70 percent of their budget to launching and scaling up innovative solutions, banks end up spending just 35 percent of their budget on innovation with the rest spent on legacy architecture.
Developed market banks, says McKinsey, “dream of an end to this Fintech cycle.” But we all know, that is not going to happen. Traditional banks need to “overhaul operating models” to remain competitive. McKinsey is of the opinion that the “call to action is urgent” – “the time for bold and critical moves is now.”
There is plenty more in the McKinsey & Company Banking Review. You may download it here.