In a report published by McKinsey titled “Global Banking Annual Review 2023: The Great Banking Transition”, on the average, global banking saw long-awaited improvement in net interest margins enabled by higher interest rates which boosted profits by about $280 billion in 2022, lifting return on equity (ROE) by 12 percent in the same year with a projection that this will post higher at 13 percent at the end of 2023.
Meanwhile, a world review of the banking sector by global management consulting firm McKinsey, has shown that Global banking posted its best performance in the last 18 months since 2007 on the back of sharp increases in interest rates in many advanced economies, including a 500-basis-point rise in the United States. It noted that in comparison ROE had been posting an average of just nine percent since 2010.
The report described the past 18 months as bringing the banks their highest highs and their lowest lows, but noted that in the last 12 months, the banking sector’s journey in cost improvement continued with cost-income ratio dropping from 59 percent in 2012 to about 52 percent last year, a seven percentage points which was driven partially by margin changes. “The trend is also visible in the cost-per-asset ratio”, which declined from 1.6 to 1.5, the report added.
The McKinsey report also found that while return on equity in the global banking landscape grew, the growth was accompanied by volatility over the past 18 months, which contributed to the collapse or rescue of high-profile banks in the United States and the government-brokered takeover of one of Switzerland’s oldest and biggest banks. “Star performers of past years, including fintechs and cryptocurrency players, have struggled against this backdrop,” the report authors stated.
The ROE Performance
Shedding light on the ROE performance, the report noted that this varied widely within categories, observing that while “some financial institutions across markets have generated a premium ROE, strong growth in earnings, and above-average price-to-earnings and price-to-book multiples, others have lagged.”
The report found that while more than 40 percent of payments providers have an ROE above 14 percent, almost 35 percent have an ROE below eight percent.
“Among wealth and asset managers, who typically have margins of about 30 percent, more than one-third have an ROE above 14 percent, while more than 40 percent have an ROE below 8 percent. Bank performance varies significantly, too. These variations indicate the extent to which operational excellence and decisions relating to cost, efficiency, customer retention, and other issues affecting performance are more important than ever for banking. Strongest performers tend to use the balance sheet effectively, are customer centric, and often lead on technology usage.”
McKinsey report
There was also geographic divergence, a recurrence from previous years, which also continues to widen, the authors noted, adding that “banks grouped along the crescent formed by the Indian Ocean, stretching from Singapore to India, Dubai, and parts of eastern Africa, are home to half of the best-performing banks in the world. In other geographies, many banks buoyed by recent performance are able to invest again. But in Europe and the United States, as well as in China and Russia, banks overall have struggled to generate their cost of capital,” they stated.
However, global banking is still challenged by the price-to-book ratio, which at 0.9 in 2022 has remained flat since the 2008 financial crisis, standing “at a historical gap to the rest of the economy,” the report stated.
Explanation for the Flatness
Providing explanation for this flatness, the report stated that it is “a reflection that capital markets expect the duration-weighted return on equity to remain below the cost of equity. While the price-to-book ratio reflects some of the long-term systematic challenges the sector is facing, it also suggests the possible upside: every 0.1-times improvement in the price-to-book ratio would cause the sector’s value added to increase by more than $1 trillion.”
Providing a future outlook for financial institutions, the report stated that it was likely to be especially shaped by four global trends.
The report identified the four global trends as, macroeconomic environment, which has shifted substantially, with higher interest rates and inflation figures in many parts of the world, as well as a possible deceleration of Chinese economic growth. “An unusually broad range of outcomes is suddenly possible, suggesting we may be on the cusp of a new macroeconomic era,” it said of the first trend that will shape the future of global banking.
It added that technological progress continues to accelerate, and customers are increasingly comfortable with and demanding about technology-driven experiences, noting in particular, “the emergence of generative AI could be a game changer, lifting productivity by 3 to 5 percent and enabling a reduction in operating expenditures of between $200 billion and $300 billion,” by the report’s estimates.
The report also pointed to a third trend, namely, that governments are broadening and deepening regulatory scrutiny of non-traditional financial institutions and intermediaries as the macroeconomic system comes under stress and new technologies, players, and risks emerge.
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