A new McKinsey & Co. report finds that banks are facing margin pressures and experiencing slower growth thanks to tech companies, not all of them fintechs.
Despite the continued expansion of total banking revenue pools, non-bank competitors and large technology companies are reducing margins for and muting the growth of the global banking sector.
A new report released today by McKinsey & Co, entitled “New Rules for an Old Game: Banks in the Changing World of Financial Intermediation,” says global banking return on equity (ROE) has ranged narrowly between 8% and 9% since 2012. Global industry market capitalization increased from $5.8 trillion in 2010 to $8.5 trillion in 2017. But growth for the banking industry has “not been spectacular,” states the report. Industry revenue grew at 2% per year over the past five years, significantly below banking’s historical annual growth of 5%-6%.
“Revenue used to grow faster than nominal GDP and it is now slower than nominal GDP [growth] and that is mainly because of margin contraction,” says Miklos Dietz, partner at McKinsey. “There is a secular trend of greater competition,” he adds, “partially coming from other banks and partially coming from new ‘digital attackers.’” Dietz is quick to point out that new competitors have not necessarily taken huge margin shares globally; however, they have been forcing banks to lower fees and costs in certain geographic areas and banking segments, ultimately cutting into banks’ margins. As an example, he cites companies in China that have entered the payment space offering products for free while traditional banks offer the same products or services for a fee.
Financial intermediaries—another area mentioned in the report—have been on a steady decline. Rushabh Kapashi, another McKinsey partner, states that financial intermediation is a “rewarding business,” with a revenue pool of some $5 trillion a year or about 190 bps. The 190 bps—which includes non-asset-based revenue sources such as payments—has dropped from as recently as 2011 when the average was 220 bps, “which indicates a downward trend in the rewards offered by financial intermediation,” he stresses. “This too has been due to increased competition from non-banks,” adds Kapashi.
There are strategic choices mentioned in the report that banks can make to stave off losses—or in some cases, increase their margins—as they fight off new competition. Kapashi says banks can: be an ecosystem orchestrator, which redefines how banks think about their businesses not only provide their own services but offer a platform where others can provide their services; offer white labelling services by taking the part of a business that has the most advantage in the value chain and doubling down on that value chain; focusing on specific clients and picking one or two areas where there is a true advantage; or transform the operational model so that processes, front-end and operations, become more cost-effective and “gives you wiggle room to compete with these nimble attackers,” explains Kapashi.
In the near future, banks and financial intermediaries will not only be confronted with fiercer competition but a raft of regulatory and sociopolitical changes, according to the report. Says the report: “Regulation has been and will continue to be a central force in the evolution of the financial intermediation system, particularly as regulators globally seek to promote transparency and greater competition, and improve the underlying safety of the banking sector,” such as open banking and greater emphasis on sustainability for banks to go beyond regulatory compliance. “These are all creating pressures on margins,” says Dietz.