What Banking Can Learn from Private Equity

By Bill Borkovitz and Chris Radigan?

It has been a rough 2023 for the banking sector so far. Over the course of just five days in March, three U.S.-based banks failed, with the most notable being Silicon Valley Bank which held more than $200 billion in assets when a bank run brought it down. In the months since, regulators have moved to address uncertainty among regional banks and shore up trust in the global financial system.

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Private equity, on the other hand, continues to outperform. The industry closed out 2022 in strong shape, after breaking all its performance records in 2021. As of now, private equity as a whole is sitting on record amounts of dry powder, is seeing growing interest from investors in search of yield, and is riding a wave of large buyout activity across multiple industries. Yes, persistent high interest rates and the inflationary environment have the potential to put a damper on PE fundraising through the remainder of 2023, but the long-term outlook for the sector remains fundamentally sound.

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It’s a tale of two industries, and there are lessons here for both sides.

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At the moment, however, banking could use the most help, and it is likely to find it in the approach that private equity has taken over the last decade-plus to maintain and build on its growth. Here are several lessons from the PE business that could help banks get back on track.

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Create value, then build on it

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Private equity firms are not passive investors. They aim to generate significant returns on their investments by actively working with portfolio companies to improve their operational efficiency, growth strategies, and overall performance. While their business model gives them the flexibility to think long term rather than quarter-to-quarter, they use this time wisely, implementing transformative changes that can yield substantial value over time.

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Banks, of course, don’t have this advantage. They are beholden to their shareholders and customers and need to maintain reserves to meet their commitments. But, although the conventional public model for banks is unlikely to change, that does not mean that the industry can’t take more of a long-term strategic approach that helps avoid the pitfalls of short-term cost containment.

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What’s more, the very first thing a PE firm does when it invests in a company is to professionalize the financial function . While banks certainly have solid accounting, they likely don’t have financial planning and analysis chops equal to what PE firms can use to drive change and grow EBITDA. Expanding their expertise on this side could help institutions more strategically create value for their customers and shareholders.

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Foster a culture of innovation

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The very business model that private equity firms operate on is reliant on innovation. That’s why, so often, PE brings fresh perspectives and new ideas to the companies they invest in that turn into long-term growth drivers. Sometimes it’s as simple as modifying the go-to-market strategy, improving customer acquisition, or developing a new product for the market. Whatever the case, out-of-the-box thinking can and often does support growth.

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Part of this shows up in PE’s expertise in using both M&A and leveraged buy-out to improve returns, identifying consolidation opportunities within industries, acquiring companies, and integrating them to create synergies and unlock value. For example, their ability to access significant capital and navigate complex M&A transactions allows them to reshape industries and drive consolidation strategies, something that banks struggle to do.

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Fostering a culture of innovation like those enjoyed in private equity starts by encouraging creativity, embracing new technologies, new business models, and exploring emerging trends such as fintech and digital banking. By being adaptable and open to change, banks can stay ahead of the curve and meet evolving customer expectations.

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Tighten up operations

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It’s no surprise that PE shops are known for their operational expertise; it is simply the nature of the mission that executives are willing to roll up their sleeves to achieve their desired results. It’s a requirement of the job.

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This translates to closely analyzing their portfolio companies’ existing operations and identifying areas for improvement, such as cost reduction, supply chain optimization, and revenue growth strategies. By implementing these changes, private equity firms aim to enhance the overall performance and profitability of the companies they invest in.

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Obviously, banks have pressure for short-term returns due to quarterly earnings expectations and market demands, but they could use the same “hands on” mentality. Process improvements don’t have to put day-to-day success at risk, especially when everyone pitches in. Done thoughtfully, operational efficiency can become an ongoing process, adapting to new market conditions and competitive forces as needed. It’s just another way that banks can prioritize long-term value creation for all stakeholders.

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Move fast without breaking things

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Private equity firms thrive on acquiring distressed companies or those facing financial headwinds and implementing strategic and operational changes to turn them around. Typically, this involves restructuring operations, improving the financial position, and positioning for future growth. PE’s speed to market is key to this process and is vastly superior to what we typically see from banks. Private equity must operate quickly in order to take advantage of the growth levers it has to improve its investment returns.

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Banks are not known for acting quickly or impulsively, and for good reason. Their business is built on trust, reliability, and structure. But that doesn’t mean there aren’t advantages in moving quickly when conditions warrant. For instance, consider what the fate of SVB would have looked like were it able to recognize and adapt to shifting market forces before they took the entire institution down. Speed isn’t always a virtue, but it does not need to be off the table entirely as a matter of course.

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Cultivate expertise

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PE firms live and die on the expertise of those on their teams, leveraging those skill sets to not only identify potential investments but also turn operational know-how into measurable improvements that drive returns.

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There is no reason that banks cannot do the same. By developing a laser-focus on specific sectors or customer segments, institutions can gain a better understanding of their clients' needs, tailor their products and services accordingly, and provide valuable insights and guidance. This can help banks build stronger relationships with their customers and drive healthy growth.

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Hiring for the bank of tomorrow

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All that said, the challenge for banking is not necessarily adopting new policies and approaches, but changing hearts and mindsets of the people tasked with making these changes. Thinking like a PE firm calls for different skills than those more common among banking professionals. How should institutions think about leveling up their teams to drive this evolution?

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Targeting seasoned operational talent from PE is, of course, one approach that could pay immediate dividends. Who else knows better how private equity does what it does than those who have done that work themselves? There are more than 80,000 people in the U.S. currently working in private equity and related investment fields – there is good motivation for some of them to move to the banking side for the opportunity to help transform a legacy industry.

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But, in the absence of available PE alumni, banks would also do well to prioritize skills that match these key areas when hiring, rather than typical banking credentials and other criteria. While non-PE hires might not be able to immediately transform operations, with the right skills and attitudes they can help build a new type of bank that incorporates best practices from both to accelerate overall change in these key areas.

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Regardless, given recent upheaval it is clear that banking needs to take a hard look at how it is structured and operates. By embracing some of the thinking that has proven effective in private equity, the industry can strengthen its own position in the market and rebuild trust amongst consumers. The next step is turning these plans into action.