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A majority of banks globally may not be economically viable because their returns on equity aren’t keeping pace with costs, according to a report from consultancy McKinsey & Co.
It urged firms to take steps such as developing technology, farming out operations and bulking up through mergers ahead of a potential economic slowdown.
“We believe we’re in the late economic cycle and banks need to make bold moves now because they are not in great shape,” Kausik Rajgopal, a senior partner at McKinsey, said. “In the late cycle, nobody can afford to rest on their laurels.”
The decade since the global financial crisis has seen a wave of innovation in financial services, bringing new competitors from fintech startups to giants like Apple Inc. and Alphabet Inc.’s Google. Banks have pondered whether to compete with, partner with or acquire some of these newcomers. Some established firms have sought to rebrand as technology companies, in part to attract hard-to-get talent.
In its report, the firm said banks risk “becoming footnotes to history” as new entrants change consumer behavior. Most recent attempts by banks to boost efficiency have been “business-as-usual,” it said.
Banks allocate just 35 percent of their information-technology budgets to innovation, while fintechs spend more than 70 percent, McKinsey said. Combined with regulatory factors lowering the barrier to entry — like open banking and looser requirements for startups — the environment is increasingly conducive for newer firms to take share from banks.
The report points to Amazon.com Inc. in the U.S. and Ping An in China as examples of technology firms that are capturing financial-services customers. To make matters worse for the old guard, the new players tend to go after the business areas that create the highest returns at banks — credit cards, for example.
Investors have taken notice. Globally, banks’ valuations have fallen 15 percent to 20 percent since the start of last year.
In Nigeria the banking index has lost some 19 percent this year. McKinsey added that “the drop in valuation suggests that investors anticipate a sharp deceleration in earnings growth.”
Lenders can cut costs and find funds for technology by outsourcing what McKinsey calls “non-differentiating activities,” including some trading and compliance functions. Banks “need to get much more comfortable with external partnerships and being able to leverage talent externally,” Rajgopal said.
Another way to free up money: get bigger.
Access Bank completed the biggest merger in Nigerian banking history in recent times when it merged with Diamond Bank.
Rajgopal said he expects M&A to continue in the late cycle.
“Going forward, scale will likely matter even more as banks head into an arms race on technology,” the report says.
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