Banking profitability held up better than expected during the Covid-19 pandemic, according to McKinsey’s Global Banking Annual Review 2021, yet half of banks are not covering their cost of equity.
Return on equity (ROE) for the industry as a whole stood at 6.7% during 2020, based on data from 905 deposit-taking institutions across the world. While not a strong performance, this is better than the 4.9% observed during the aftermath of the financial crisis in 2008, and better than many analysts expected. Banking ROE was hit in every region; North America, for example, saw ROE fall from 12% in 2019 to 8% in 2020, with similar declines in Europe (from 6% to 3%) and Asia (from 7% to 6%).
The report reflects significant uncertainty in forecasting the likely trajectory for future overall global banking ROE, with McKinsey estimating that it will recover to between 7% and 12% by 2025. The wide variation depends on three significant factors outside of banks’ control: inflation and interest rate increases, government support for economic recovery, and liquidity (relative levels of spending and saving in the economy). These variables will, it says, determine whether the industry will operate in the upper (12%) or lower (7%) range.
McKinsey’s analysis found that 51% of banks are operating with an ROE below their cost of equity, and for 17% of banks their ROE is more than four percentage points lower than the cost of equity. In addition to the disruption brought by the pandemic, the report also cites the ongoing challenges of operating within a low-interest-rate and high-capital-requirements environment as factors driving up the cost of equity and pushing down returns.
These ongoing challenges also show up in valuations, with bank shares trading at around one times book value (the net value of a firm’s assets), versus all other industries trading at about three times book value.
In an analysis of the market capitalisations of 599 financial services institutions between February 2020 and October 2021, McKinsey found that just 65 could be described as ‘outperformers’, with gains of more than $8bn, and 15 were what it deemed ‘underperformers’ with losses of more than $8bn. Some 519 firms were in the middle, with gains or losses of up to $8bn.
Of all the gains in market capitalisation in this group, 50% went to specialist providers, payment companies, financial exchanges and securities and investment banks. The majority of universal banks saw only small gains in their share price or lost value. The report argues that in order to attract investors, and to remain profitable into the future, banks will need to embrace new business models, which are digitally enabled and more embedded into their customers’ lives.
