Banking Industry- what is in store

Banking Industry- what is in store

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Banking industry is facing many challenges in the past particularly from 2029 onwards. In 2019-2020 it is Pandemic and followed by Inflation and war. The increased inflation give rise to increase in Interest rate. The Zero interest regime is the old story and now interest rate moving to the northern direction.?Adding to that, Banking is moving to the digital technology and there are more competition outside the banking system particularly the fintech.?Banks overall continue to trade at a steep discount to other sectors, a reflection of the fact—confirmed once again in 2022—that more than half of the world’s banks earn less than their cost of equity. In nutshell the banking industry is at roller-coaster ride.

?Year 2022.

The year 2022 has been tumultuous year of shocks and growing uncertainty. Banks rebounded from the pandemic with strong revenue growth, but the context has changed dramatically. Now a series of interrelated shocks—some geopolitical and others lingering economic and social effects of the pandemic—are exacerbating fragilities.

Bank profitability reached a 14-year high in 2022, with expected return on equity between 11.5 and 12.5 percent. ?Revenue globally grew by $345 billion. This growth was propelled by a sharp increase in net margins, as interest rates rose after languishing for years on their cyclical floors. For now, the banking system globally is sitting comfortably on Tier 1 capital ratios between 14 and 15 percent—the highest ever.

The improvement in margins accounted for 60 percent of the revenue gains. Almost all segments of banking have seen improvements—capital markets and investment banking being the exception.

Nonetheless, more than half the world’s banks in 2022 continue to have a return on equity that is below the cost of equity. For the second half of 2022, the margin increases delivered returns above the cost of equity for just 35 percent of banks globally. And less than 15 percent of banks are earning more than 4 percent of their respective cost of equity.

The longtail effects of the COVID-19 pandemic are still being felt, and the Russian invasion of Ukraine in February 2022 and heightened tensions over Taiwan marked the rude return of geopolitics as a disruptive force. Five resulting shocks are affecting banks globally:

• Macroeconomic shock. Soaring inflation and the likelihood of recession are sorely testing central banks, even as they seek to rein in their quantitative-easing policies.
• Asset value shock. These include steep declines in the Chinese property market and the sharp devaluation of fintech’s and cryptocurrencies, including the bankruptcy of some high-profile crypto organizations.
• Energy and food supply shock. Disruptions to the energy and food supply, related to the war in Ukraine, are contributing to inflation and putting millions of livelihoods at risk.
• Supply chain shock. The disruption of supply chains that began during the first pandemic lockdowns continues to affect global markets.
• Talent shock. Employment underwent major shifts during COVID-19 as people changed jobs, began working remotely, or left the workforce altogether to join the “great attrition”—shifts with no sign of easing.

The growth in banks is seen some pockets of geographies ?such as many regional banks in the United States and top five banks in Canada and in emerging economies such as India, Indonesia, Mexico, and South Africa.

As the economy slows, the divergence between banks will widen further

The current uncertain macroeconomic outlook will affect banks in two ways,

ü?continuing boost to profitability from higher margins as interest rates increase—but this may prove transitory.

ü?long-term growth slowdown.

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Two economic scenarios: How bad (or good) might it be for banks?

This will lead to ?inflationary growth and stagflation and it is positive at the initial stage. Rising interest rates will lift net interest as short-term lending products such as consumer finance are repriced faster than liabilities. Global banking revenues are likely to see an increase of 5 to 6 percent in 2022.

The big question is what will happen during a transition phase when economic growth deteriorates, followed by a phase when the full effects of the scenario kick in. Banks could see three effects—a slowdown in volume growth, higher costs, and greater delinquencies—which, depending on the scenario, could be small or large.

What hasn’t changed: Banks trading at a growing discount to other sectors

Banking as a sector is valued substantially below other industries, a reflection of the stark legacy challenges that traditional banks face. About half of all banks are net destroyers of value, and many of the others are weighed down by prospects of slow growth and low expectations for profitability.

Banks’ performance varies by geography, specialization, customer segmentation, and scale

To understand why and how banks end up where they do, across four dimensions: geography, specialization, customer segmentation, and scale.

Geography is a key factor. Geography emerges as one of the key factors in a bank’s valuation. Overall, bank’s primary business location accounts for 68 percent of its valuation, a share that has been rising consistently since 2014.

Last year, many banks in Europe were already unprofitable; only 25 percent of the 300 largest European banks were valued above book in 2021. In the months ahead, they face intensified pressure from a potential recession. By contrast, about 25 percent of emerging Asia banks are valued at 1.5 times their book value or above, in part because of fast-growing economies and their innovative practices. P/B and return on equity are also strong in the Middle East, Latin America, and North America.

Specializing can be profitable. Well-valued specialist players and fintechs are—not surprisingly—active in banking products that generate profits, including deposits, payments, and consumer finance. Overall, the banking system destroyed about $120 billion in economic value in 2021, with a return on equity that failed to match its cost of capital. But the divergences were very large across areas of banking specialization.

Take a fresh look at customer segments and demographics. In retail banking, disproportionate revenues tend to be locked in specific segments. One notable feature of this analysis is the gap between the demographic distribution of the population and the age at which they generate banking revenue. For example, in the United States, banking revenue peaks among people between the ages of 60 and 70, which is about 40 years after the demographic peak. In China, the trend is reversed: the revenue peak arrives 20 years before the demographic peak.

Scale matters. About 70 percent of market capitalization is held by banks that have a P/B?of higher than 1 (which is about half of all banks)—even though they account for only 30 percent of assets. Only 10 percent of these banks are already at scale, and they represent a market share of at least 10 percent; the rest of these “value-creating” banks could benefit from M&A to increase their scale.

The dual challenge: Managing the present while preparing for the future

Over the next five to ten years, market pressures and shifts, including technological changes that disrupt traditional banking, will amount to fundamental structural breaks. Banks will need to improve their short-term resilience and invest in the long term to innovate and prepare the path for future profitability, increased growth, and higher valuations.

In the near term, four strategic objectives can help bolster resilience:

1. Financial resilience. The best-performing banks will have a net income structure with low sensitivity to interest rates and risk costs, and they should target a cost-to-income ratio of 35 to 40 percent.
2. Operational resilience. That means reducing or eliminating a presence in high-risk countries and building exceptional risk management practices.
3. Digital and technological resilience. Cyberattacks remain a serious risk, and the best banks have a well-protected and future-proof technology infrastructure, as well as superior data security.
4. Organizational resilience. Banks that perform best will have rapid reaction times and invest in attracting, reskilling, and retaining the best talent.

For the longer term, banks will need to move from traditional business models to more future-proof platforms, potentially decoupling business units such as everyday banking and complex financing or advisory services. Banks could consider several approaches. For example, they could foster highly differentiated customer relationships, with a strong focus on establishing a deep emotional connection. They also could develop proprietary data and insights on sets of customers, including with the use of advanced analytics. A third option would be to make substantial and clear bets when allocating resources and capital. Fourth, banks could create new customer access and revenue sources, such as subscription fees, payments fees, and distribution fees, that do not involve the balance sheet. And banks could focus on innovation, with the goal of instilling a truly entrepreneurial culture and attracting and retaining the talent needed to contribute within such a culture. Finally, as we describe in the next section, banks could develop a strategy for targeting environmental transformations.

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Source :https://www.mckinsey.com/featured-insights/themes/global-banking-in-review-a-new-era?cid=other-eml-alt-mip-mck&hlkid=5b9de482fa0844a2b60e09daf8e1389a&hctky=13241930&hdpid=0ae069e8-c6d2-420c-910e-f5a349d01fc6