Return on equity remains a depressing story and only those banks embracing digital have any hope of turning things around, writes Brian Caplen.

Post financial crisis, leading banks in advanced countries struggled to make decent returns, but banks in fast-growing emerging markets prospered. This is now changing. These days geography is much less important in determining returns – the key factor is digital. ​

The latest global banking annual review from McKinsey contains some revealing numbers to illustrate this. While back in 2010 74% of the difference in valuations between banks was down to geography, in 2017 it only accounts for 39%. The rest is to due to having the right business model, of which digital is the key component.

At present, the average return on equity (ROE) for banks ​is between 8% and 10%, which is about the same as their cost of equity – hardly a compelling case for investors. With interest rates on the rise and some of the heavy lifting of cost cutting completed, bankers could be fooled into thinking the worst is over.

But that is to ignore the threat of digital disruption. McKinsey’s most optimistic outlook for ROE is 9.3% by 2025 – not exactly a ​reason to be popping open the champagne. But if banks fail to invest in digital and see large chunks of their business going​ to new players, this could diminish to a paltry 5.2%.  

Making the investment case for digital transformation can be tough. Sometimes it’s a case of making a costly upgrade just to hang on to existing business, rather than bringing in massive growth. But what these projections show is that the situation is a lot more dire. Either banks make the investment and move forward, or they put their long-term existence in doubt.Brian Caplen is the editor of The Banker

Follow him on Twitter @BrianCaplen

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