Global Banking Annual Review 2018 - McKinsey & Company

New rules for an old game: Banks in the changing world of financial intermediation

McKinsey Global Banking Annual Review 2018

Authored by: Miklos Dietz Paul Jenkins Rushabh Kapashi Matthieu Lemerle Asheet Mehta Luisa Quetti

Contents

Executive summary

5

The state of the global banking industry

8

The transformation of financial intermediation

19

Reimagining banking in a new world of financial intermediation

38

Executive summary

This is McKinsey's eighth annual review of the global banking and securities ("banking") industry. It is based on data and insights from Panorama, McKinsey's proprietary banking research arm, as well as the experience of clients and practitioners from all over the world.

A decade after a financial crisis that shook the world, the global banking industry and financial regulators have worked in tandem to move the financial system from the brink of chaos back to a solid grounding with a higher level of safety. In numerical terms, the global Tier 1 capital ratio--one measure of banking system safety--increased from 9.8 percent in 2007 to 13.2 percent in 2017. Other measures of risk have improved as well; for example, the ratio of tangible equity to tangible assets has increased from 4.6 percent in 2010 to 6.2 percent in 2017.

In the first chapter of this report, we provide a perspective on the industry's current state and valuation. Performance has been stable, particularly in the last five years or so, and when the above-mentioned increases in capital are figured in. Stable, but not spectacular. Global banking return on equity (ROE) has hovered in a narrow range between 8 and 9 percent since 2012. Global industry market capitalization increased from $5.8 trillion in 2010 to $8.5 trillion in 2017. A decade after the crisis, these accomplishments speak to the resiliency of the industry.

But growth for the banking industry continues to be muted--industry revenues grew at 2 percent per year over the last five years, significantly below banking's historical annual growth of 5 to 6 percent.

Compared to other industries, the return on equity of the banking sector places it squarely in the middle of the pack. But if we look at banking

from an investor's point of view, we experience a jarring displacement: the banking sector's price-to-book ratio was consistently lower than that of every other major sector over the 2012-17 period--trailing even relatively sluggish industries such as utilities, energy, and materials. This difference persists even when other valuation multiples, such as price-to-earnings ratios, are compared. In part, this report attempts to understand why investors lack confidence in the future of banks.

What do investors know, or think they know, about the future prospects for the banking industry? In part, low valuation multiples for the banking industry stem from investor concerns about banks' ability to break out of the fixed orbit of stable but unexciting performance. Lack of growth, and an increase in non-performing loans in some markets, may also be dampening expectations. Our view, however, is that the lack of investor faith in the future of banking is tied in part to doubts about whether banks can maintain their historical leadership of the financial intermediation system.

Our second chapter examines this system in depth. By our estimates, this financial intermediation system stores, transfers, lends, invests, and risk manages roughly $260 trillion in funds. The revenue pool associated with intermediation--the vast majority of which is captured by banks-- was roughly $5 trillion in 2017, or approximately 190 basis points. (Note that as recently as 2011, the average was approximately 220 bps.) In part, this report will explore how this $5 trillion revenue pool could evolve over time.

Banks' position in this system is under threat. The dual forces of technological (and data) innovation and shifts in the regulatory and broader socio-political environment are opening great

New rules for an old game: Banks in the changing world of financial intermediation

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