It is remarkable that despite the turmoil of the past 18 months, banks enjoyed their highest profits in more than a decade. Still, lenders must adapt to the great banking transition, according to McKinsey’s Global Banking Annual Review 2023, because a multi-decade evolution is underway.
Alexander Edlich, senior partner at McKinsey and one of the report’s co-authors, says that banks have a historic opportunity to reinvent themselves across balance sheets, transactions and payments.
Changing risk environment
Mr Edlich points to three key global trends which will shape banks’ outlook: the shifting macroeconomic context, the regulatory environment and technology.
As macroeconomic dynamics shift, higher interest rates and inflation figures, together with China’s potential economic deceleration, are opening the door to a new macroeconomic era, according to the report.
Layered upon the changing macroeconomic environment is the increased regulatory scrutiny of banks. The Basel III Endgame reforms, for example, will likely result in higher capital requirements for large and medium-sized banks. “This affects what banks will be required to hold in terms of capital, and the attractiveness of some products, client segments and geographies,” Mr Edlich says.
“That’s an important driver of capital return, uses of capital, sources of capital and strategic decisions about where these institutions are going to invest.”
Technology presents many opportunities for banks. For example, generative artificial intelligence could lift productivity by between 3% and 5% and generate a reduction in operating expenditures of between $200bn and $300bn, McKinsey predicts.
But the increased cyber risk it brings requires constant vigilance, according to Mr Edlich. “Technology-driven risk is a massive driver of investment spend, as well as concern for management teams, boards and regulators,” he says.
Many clients have said that this has been the hardest year of being a banking CEO [that they have experienced].
Data — and who owns it — will be defined by incoming regulation, says Miklós Dietz, co-author of the report and senior partner at McKinsey. “Data could be the new oil, or it could be the new water; it will either be an incredibly valuable resource owned by a few players, or a utility available for everyone,” he adds.
But above all, “sheer velocity” underpins financial institution risk, says Mr Dietz. While banks have seen many of these risks before — particularly geopolitical risk — the difference now is the speed at which such risks can affect businesses across the globe.
“Changes are happening in days and weeks that used to take a year,” Mr Dietz says. “Many clients have said that this has been the hardest year of being a banking CEO [that they have experienced].”
And this is not because everything is bad, he adds, but because opportunities can themselves be stressful.
Navigating risk breadth and speed
“Banks must expand their risk capabilities,” Mr Dietz says. “Traditionally banks have been very strong on credit risk and maybe operational risk, but now they need to have broader risk talent.”
Agile governance is also key. “True agility, not traditional old school agility,” according to Mr Dietz. “It’s ‘agile 2.0’.”
According to Mr Dietz, agile 2.0 can include flexing or unbundling strategies, such as moving business off balance sheet to help distribute risk to a broader set of investors, or separating out customer-facing businesses from banking-as-a-service businesses, for example.
Comparable unbundling happened in the telecom and semiconductor sectors in previous decades. McKinsey describes how, as telecoms struggled to develop customer-facing strategies to keep up with mobile phone demand, firms split into wholesale network providers and retail providers, separating their capital-intensive, low-return-on-equity business from customer-facing, high-return business.
Ultimately, their solution was not trying to do everything under one roof, Mr Dietz says, “or even if it is under one roof, separate them a little bit more”.
Whether to flex or to fully unbundle is particularly relevant to capital-heavy banks, but is “not an all-or-nothing proposition”.
Emerging regional trends
According to McKinsey’s report, banking sectors in Asia, Latin America, the Middle East and Africa are increasing revenue faster than those in developed economies. But despite the focus on Brazil, Russia, India, China and South Africa (Brics) in recent years, the attention has shifted away from these countries more recently, with the exception of India.
There is a substantial reshaping of which geographies drive growth, banking and innovation, according to Mr Dietz. “It used to be the Brics, but they are not the engine [of growth] anymore. Those countries are some of the less performing areas of the world, with the exception of India,” he says.
Reference to Brics, as well as the term ‘emerging markets’, no longer work as a geographic concept of value creation in banking, Mr Dietz explains, suggesting that a new centre of gravity for the banking industry has emerged along the coastline of the Indian Ocean.
Currently, what McKinsey calls the “Indo Crescent” area hosts the world’s fastest-growing financial hubs, including Dubai, Mumbai, Nairobi and Singapore.
“These countries constitute only 8% of banking assets today, but represent a staggering 52% of banks who are truly creating value in terms of profitability, and also in terms of stock market valuation,” Mr Dietz says.
And this is not just owing to regional population growth, but because of financial institutions’ leapfrogging opportunities, for example jumping ahead of competition by adopting emerging technology.
“Leapfrogging is a very important concept for [challenger] banks. They have less history and often find it extremely easy to totally reinvent their business models,” Mr Dietz says. He points to the development of mobile payments systems in Africa as an example, describing several countries there as “vastly more digital than the US”.
Banks in India and south-east Asia have been very creative in reinventing financial services. “[They are] not just doing banking, but going beyond banking,” says Mr Dietz.
Many banks have rolled out super apps and technology solutions, with some players “literally turning themselves into technology platforms”, Mr Dietz says. Other countries in the region have been very sophisticated in adapting to risk, he adds, “playing the risk game better than others”.
According to Mr Dietz, the Indo Crescent area has the potential to drive global growth over the next decade. Between 2021 and 2030, McKinsey predicts these economies will grow at 7.3% per year, compared with 6.0% for Brics (excluding India) and 4.3% for the rest of the world.
