The pressures on banks to overhaul their business models are growing stronger as the world economy slows down, with mid-sized banks the worst affected, writes Brian Caplen.
Nearly 60% of banks are producing returns below the cost of equity with a marked deterioration in emerging market returns overwhelming a slight uptick in meagre developed market returns over the past five years. This is the sorry state of global banking as the industry enters the late phase of the economic cycle with slowing loan growth and weakening investor confidence.
These are the stark findings of the 2019 McKinsey global banking review entitled ‘The last pit stop? Time for bold late-cycle moves’. McKinsey finds that returns on tangible equity of emerging market banks declined from 20% in 2013 to 14.1% in 2018. Developed country banks improved slightly but from a very poor starting place: going from 6.8% in 2013 to 8.9% in 2018.
McKinsey says that scale, geography and performance are the factors distinguishing the "the 40% of banks that create value [from] the 60% that destroy it’’. The 20% of banks that are market leaders account for almost the entire industry value added whereas the 55% of banks that are sub-scale are at risk from a downturn unless they rapidly overhaul their business models.
Cutting costs is essential and a zero-based budgeting approach is recommended in which every cost item is challenged in its entirety rather than relying on year-on-year comparisons. Many of the struggling banks are in western Europe, where the banking environment of low interest rates and poor growth has been a reality for a long time.
Logically, such circumstances should lead to banking consolidation and McKinsey suggests that in-market mergers of banks with comparable franchises could produce cost savings of as much as 20%. But history shows that this is a route fraught with difficulties that can produce as many own goals as victories. Nothing is easy in the current banking environment.
Brian Caplen is the editor of The Banker. Follow him on Twitter @BrianCaplen
Register to receive my blog and in-depth coverage from the banking industry through the weekly e-newsletter.
