McKinsey’s Global Banking Annual Review 2020 is out and, despite the obvious challenges of this year, positivity is in the air. But more work is needed. TMI talks to one of the report’s authors, McKinsey Senior Partner Matthieu Lemerle, about some of the key findings and their likely impact on customers.
The banking sector has had something of roller coaster ride over the past decade or so, the impact of the pandemic delivering one of the biggest impromptu ‘stress-tests’ in decades. But according to the latest McKinsey Global Banking Annual Review, the response from the industry demonstrates “resilience and purpose”, notwithstanding the fact that “the economic impact on the industry has been and will continue to be severe”. Indeed, says the review, “amid a muted global recovery, banks will face a profound challenge to ongoing operations that may persist beyond 2024”.
Thank you, regulators
The review details solutions for the longer-term health of the industry and continued support of customers. However, London-based Lemerle, believes that the scale of severity and hardship of the economic impact of this pandemic without the banking industry would have been “unthinkable”. But he notes that “in providing this role to society, the impact on banks themselves has been severe”.
In his analysis, Lemerle compares current events with those of the 2008 financial crisis but sees a “fundamentally different” position, where this time round “banks were not the cause”. Attitudes have changed too, he says, with banks finally understanding that “they have a role to play in helping to restore livelihoods”.
With the predicted “long winter” of low, zero or negative interest rates, banking returns on equity (ROE) and revenues can expect challenging times ahead. Indeed, the review suggests revenue losses of up to $4tr. could be seen over the next four years. However, there is evidence that on this occasion, the banking sector has demonstrated far more resilience, notes Lemerle.
The raft of regulations that were imposed on the sector post-2008, seems to have absorbed the worst effects of pandemic, he explains. Not least of these is the stringent capital buffers demanded across the industry.
Of course, it’s doubtful if any bank had current events as a stress-test scenario in its arsenal to work from, but what matters is the outcome, states Lemerle. The review calculates that 83% of banks have a less than 5% chance of falling below regulatory buffers, and that, absent of any response to the expected pandemic impacts, only 3% of banks globally (that’s around 0.6% of total banking capital) had a greater than 50% chance of falling below the minimum.
Whatever happens, banks must now consider a set of immediate and medium-term actions to mitigate the financial impact of the pandemic, and the upstream effects these will have on customers and the wider economy, says Lemerle.
The review indicates regional variations in sensitivity to the impact, but generally indicates that the best short-term response will comprise a mix of three levers. These are: leverage of revenue (although banks operating in a low, zero or negative interest rate environment may struggle here); productivity improvements; and increasing the accuracy with which capital and risk-weighted assets (RWA) are calculated. Of the latter, Lemerle says banks should either be aiming to get back to their pre-crisis ROE levels or, in the case of Europe where pre-crisis ROE was way below cost of equity at 6.3%, “having the ambition to do better”.
In practical terms, “there is no real innovation needed”, comments Lemerle. However, he feels lessons may be drawn from regional differences in bank responses to the 2008 crisis. With US players being “much more decisive” than their European counterparts, ultimately he believes that the US industry “came back faster and stronger”.
The means of ensuring the longer-term health of banks – and, by extension, their clients – covered in section three of the review, looks first at a number of pre-existing trends. It lists these as follows:
- Accelerate the shift to digital and reconfigure the branch network
- Systematically redeploy the workforce and reskill at scale
- Transform technology to scale with demand
- Reset third-party spend through demand respecification and supplier management
- Move to minimum viable central functions
- Find the right hybrid remote/onsite model and shrink the property footprint
“What the crisis has done is accelerate these trends, forcing banks to pay attention,” comments Lemerle. The details can be read in the report, but essentially the response demands a three-point bank agenda for action.
Agility and speed
The first is to “keep what works”. In the early days of the pandemic, when there was a genuine fear of a liquidity crisis, the review research reveals that banks even surprised themselves by the speed with which they could make decisions, says Lemerle. “The balance between keeping staff safe through remote working, maintaining operational effectiveness for customers, risk containment, and in many cases becoming the conduit for state aid, pushed bank agility to the fore, with top-down empowerment enabling quick decisions.”
As an example of something that worked, by focusing on customer needs, supporting their operations despite lockdown conditions (for corporate clients, enabling digital signatures to be used, for example) banks have “endeared” themselves to customers. The review even shows that Net Promoter Scores, measuring the willingness to recommend a product or service to others, increased across the board during the pandemic.
“The big question now is how to crystallise and retain that advantage,” says Lemerle. He sees “forward-looking banks” busy working out how to embed their new-found speed and agility across their organisations. “But the window of opportunity is relatively short, with people very likely to go back to their old ways after the pandemic,” he warns.
Facing “a long winter of zero percent interest rates” and a number of other economic challenges, the anticipated reduction in net interest margins will push banks towards a fundamental reinvention of their business models, says Lemerle. This is the second action point.
The most important factor for banks now is therefore to work out how to operate in a ‘lower for longer’ environment. “It’s unlikely anyone can fully offset the effects of depressed rates, as the impact trickles from the front book to the back book,” he says. “However, we detail in the review some interesting experiments by some players who are trying to create more fee income, for example through subscription models.”
Technology is another point of reinvention, especially when it comes to driving productivity improvements. Although this has been a ‘known known’ for some time, with many banks keen to “adopt the challenger playbook”, Lemerle says the pandemic has accelerated the adoption of digital trends in most parts of banking, as it has among corporate clients. The volume of this conversation will only increase.
A third element of reinvention is about bringing environmental, social, and governance (ESG) issues to the fore, where banks collaborate with the communities they serve to “recast their contract” with society.
“Until fairly recently, many banks had statements on ESG, but in a number of instances they were only reactive to the pressure of regulators and activists,” notes Lemerle. “I think a pivot, which began before the crisis, and which has been accelerating during the crisis, was when bankers understood that not only is it actually the right thing to do for the communities in which they operate, and for the stakeholders with which they collaborate, but also that it’s just good business.”
There have been several events during 2020 that have pushed certain issues to the fore. There has also been a maturing of the approach to climate and transition-based finance. “We see a massive acceleration of banks trying to build sustainable business models that enable them to work with industry and help the transition from brown to green,” explains Lemerle. “There’s a whole business opportunity out there for the banks but it requires significant retooling of the industry.”
Bankers now must fully understand the industries in which their clients operate if they wish to be credible in this space. This means not only grasping the science and technology driving transition, and the precise nature of the issues each client is facing, but also adapting their financial product sets to be relevant to each client’s ESG needs. It also means learning how to properly risk assess and underwrite these instruments, and measure their impact on the bank, the clients and even their supply chains.
Human after all
It may seem like a tall order, but banks that can reinvent their business model, accelerate their digital agenda, and genuinely embrace ESG, will, Lemerle believes, “have a bright future after this crisis”. It’s a positive take on a rather gloomy time, especially, he admits, that when McKinsey set out to write the review, the expectations were predominantly negative.
However, despite the difficulties of encapsulating wildly fluctuating levels of uncertainty created by the pandemic, there were two distinctly positive surprises for the team: that the banking industry is very resilient; and, most importantly, that banks are now very much part of the solution.
“After a decade of being on the wrong side of many things, banks are now active actors in restoring livelihoods,” Lemerle declares. “They are playing an essential role in keeping economies running.” And with the review indicating that many banking CEOs are mindful that they need to capitalise on the gains in positive perception before that window slams shut again, now might be a good time for corporate treasurers to start building better relationships.
The full review can be found here: https://www.mckinsey.com/industries/financial-services/our-insights/global-banking-annual-review