The banking sector is at a turning point. Key measures for banks are at a historical low point. The sector’s price-to-book value has fallen to less than one-third the value of other industries. That gap is less the result of current profitability and more about uncertain profit growth in the future. While banks have pushed for great improvements recently, margins are shrinking — down more than 25 percent in the past 15 years and expected to fall to 30 percent (another 20 percent decrease), in the next decade.
Regulation and increasing intersectional competition are still worries, but the bigger threat is a global trend: new challenges — often from different industries and often benefiting from the kind of cross-industry platforms behind the recent success of companies such as Amazon, Google, Microsoft, PayPal, and Spotify — with a vastly superior economic model. The market believes that banks are headed in the wrong direction, without a future-proof strategy.
We believe that the skeptics are right about today and wrong about tomorrow. Banking is facing a future marked by fundamental restructuring. But we also believe that banks that successfully manage this transition will become bigger and more profitable and grow faster while leading to a value creation opportunity of up to $20 trillion.
In the next era, banks can realign to compete in new arenas, organized around distinct customer needs. These arenas will expand far beyond the current definition of financial services, and they will also be hotly contested by a wide range of tech giants, tech startups and other nonbanks. But this daunting reorganization, or breakup, could also provide banks with a huge opportunity: higher margins, new revenue streams, and loftier valuations. Ambitious banks can break free from stagnant valuations, thrive and grow if they are willing to embrace the platforms of the future and make a few strategic, informed big bets.
Why break up? First, economic forces and technology have ended the run of the universal-bank model, and investors already are recognizing radical specialization to be greater than the traditional one-stop shop. By contrast, the future model relies on breaking up into four specialized platforms we will describe. Organizing around these areas will be a structural advantage.
Of course, we don’t know exactly what banks will look like in the future. Regulation, technology, geopolitical shifts and unforeseen innovations could alter the way the industry develops. But we do believe the banks that successfully manage the coming transition will use tech and data to embed themselves deeper into customers’ lives with real-time services that were unimaginable just a few short years ago. The opportunity is great for those who move fast into this new future.
BANKING IS LOSING ITS TRADITIONAL ADVANTAGES
Until recently, big banks drove profits and growth by applying synergies, economies of scale, and access to huge pools of capital. This massive industry already manages an estimated $370 trillion in worldwide assets, and its growth is accelerating. We project that global assets will grow to between $500 trillion and $550 trillion in the next decade.
While traditional banks have been convenient one-stop shops for businesses and consumers, many haven’t evolved their products in a way that matches the tech-driven pace of change in other industries. Products such as checking accounts, loans and even corporate advisory can seem undifferentiated. And people increasingly feel frustrated by the financial fragmentation that banks have imposed on many consumer processes. For instance, buying a home once required navigating a confusing world of disconnected real estate brokers, mortgage lenders, insurance companies, lawyers, renovation contractors, and so on. Our grandparents tolerated those frustrations, but they also used pay phones. There were no other options. Today, we are awash in new ways to reach and connect with consumers. Banks need to identify and engage these customers — as their newer competitors are doing.
To compete, most banks will have to embrace cross-industrial platforms. These new platforms dismantle the barriers between traditional industries, reshaping customer behavior and turning formerly linear value chains into ecosystems that fulfill customer needs in new ways. The process has already reached critical mass in industries such as healthcare, media, music and retail, where diverse players are connected by platforms created by global leading companies that have been amply rewarded by the global capital markets. In contrast, banks have been consistently undervalued by the capital markets, making banking the lowest-valued sector in the world in 2021.
Because of cross-industrial “platformization,” banks must now compete with any organization that has the capacity and desire to offer any kind of financial services. Global tech giants such as Google and Tencent have used their platforms to offer banking services seamlessly to their millions of customers. But new competition is booming exponentially around the world.
Tech advances have eliminated size as an advantage in providing excellent services, winning customer loyalty, aggregating and analyzing data, and building networks of capital. Roughly 200 digital banks have launched since 2015, as have new brokerages such as Robinhood, wealth-advisory services such as Betterment, alternate investment banking paths such as special-purpose acquisition companies, payment platforms, and startup capital platforms such as SeedInvest Technology.
The new competitors have raised the bar on customer expectations. Both individual and organizational customers now seek a long list of attributes from their financial-service providers. Surveys show that these desires include high levels of personalization, zero friction, and a commitment to social and environmental impact. The markets believe the newcomers can meet customers’ demands. As of September 2022, there were at least 274 fintech companies with a unicorn valuation of more than $1 billion, up from just 25 in 2017. Collectively, they have a market value of more than $1 trillion.
Many traditional banks, on the other hand, face stagnant or decreased revenue and profits. The average global banking ROE was around 9.5 percent in 2021 — a significant recovery from 6 percent in 2020, but a sharp decline from 15 percent prior to the 2008 crisis. By 2030, we project that it will fall below 7.2 percent.
These falling margins are contributing in turn to weaker stock market valuations. Banking stocks trade at an accelerating discount to other industries, from a 15 percent discount in 2000 to a 70 percent discount in 2022. This means global investors are voting with trillions of dollars against the future profitability and sustainability of the existing business model of universal banks.
COMPETITIVE BUSINESS MODELS EMERGING IN BANKING
The era when all financial services were dominated by monolithic banking entities is over. What, then, will arise to take its place? We believe the future of banking will be contested by banks and nonbanks in five cross-industry competitive arenas: everyday banking, investment advisory, complex financing, mass wholesale intermediation, and banking as a service.
While these arenas encompass the products and services provided by banks today, they will be redefined and reinvented by different customer needs. This new competitive landscape has transformative potential. In the next decade, revenues for all these arenas could grow dramatically, by as much as three to 30 times.
In each of the five arenas, we see the potential for at least two platform business models. These 10 platforms aren’t theoretical models. They are trends that we already see in progress among organizations that are winning better valuations in the capital markets.
Everyday banking: Everyday banking encompasses day-to-day financial services, such as checking and savings accounts, credit cards, personal loans, payment processing, and lines of credit on the traditional banking side. This arena will also include ecommerce ecosystems, loyalty programs, discounts, advertising and peer-to-peer marketplaces — making banking not a chore or obligation but something easy and even enjoyable. For small- and medium-size enterprises, it will include tools to help organizations manage their finances. The common thread of all these services is that customers want them to be hassle free, reliable, highly automated and inexpensive in their day-to-day life. The ultimate goal for everyday banking is invisibility — offering services that are cheap and easy and accessible through all channels via business models.
Investment advisory: Investment advisory is the arena to provide investment and insurance products for all kinds of customers, from young people just starting to build wealth to older people who need sophisticated investments and protection to institutions. This includes financial planning, brokerages, trusts, retirement plans and many kinds of insurance. People crave tailored advice and trust-based relationships that make them feel understood, even when dealing with virtual advisers online. On the business side, this arena comprises the advisory aspects of investment banking and other financial advice services. The goal for investment advisory is superb personalization, blending the human touch with digital efficiency through business models.
Complex financing: Complex financing is the arena for individual and business services that require more sophistication than everyday banking. Examples include mortgages, home equity loans, car loans and startup loans. Such services are complex because many kinds of players are part of each ecosystem. While familiar, these products and services are used less frequently than others, but they have a big impact on the customer. For instance, getting a mortgage is just one aspect of buying a home, which requires navigating a maze of real estate brokers, lenders, insurers, attorneys and other professionals. Consumers crave a trusted expert to help them get through that maze and simplify it, weaving it into a single touchpoint. The end goal for complex financing is journey integration — making these processes convenient, efficient, fast and low cost yet also as personalized as possible from start to finish.
Mass wholesale intermediation: Mass wholesale intermediation is the corporate-focused arena. It’s a combination of expertise and new, efficient systems. It includes corporate finance, cash management, portfolio management, M&A advisory, equity and debt financing, and other traditional investment banking offerings. The ultimate goal for mass wholesale intermediation is extreme efficiency and the know-how banks can pursue through various business models.
Banking as a service: Banking as a service is the only arena that’s not customer facing. Providers create highly efficient tech and infrastructure platforms they can license to customer-facing organizations. Some will offer credit to nonfinancial institutions, enabling them to act as banks; and some will bolster the balance sheets of existing financial institutions. The goal for banking as a service is utility — giving clients robust, secure, and efficient services and liquidity.
NEXT PHASE OF BANKING FOR INCUMBENTS AND CHALLENGERS
The successful bank of the future will be defined as a network of platforms. Few banks will capture all platform opportunities, but many will participate in multiple platforms. Given the platforms’ enormous value creation scale, getting even one right can unlock tremendous value for shareholders and broader stakeholders alike. But success will come to only those banks willing to move beyond their traditional operating models. Banks should be prepared to evolve through multiple stages on their way to becoming a platform network.
This vision of the coming shakeout may seem daunting. But the challenges are manageable taken one step at a time. The first and most important step is to commit to adapting as soon as possible. Banks and nonbanks that begin to transform themselves now will have a huge advantage over competitors that become paralyzed with indecision and confusion.
The good news is that there’s still enough time for most financial institutions to transform their business models. Additionally, the capital markets are likely to be very supportive in valuing those transformations over the next five to 10 years.
For challengers looking to exploit a tech edge as a way of entering banking, the first step is to analyze which arenas offer maximum advantage based on that edge and which platform-based business model makes most sense. These organizations will have the advantage of not being tied to the old standards and practices of traditional financial services. But they need to be mindful that this advantage doesn’t guarantee success, even for companies with cutting-edge innovations.
To be clear, this transformation will take time, but leaders who move fast, stay ahead of the curve, and remain patient can break out of today’s stagnant growth trajectory and put themselves on a strong valuation path. Many banks already are moving forward and getting recognition from the market.
Ultimately, whether you are the leader of a company that depends on banking or a consumer hoping to enjoy better customer service in your life, there is a lot to look forward to.
The new era of banking will arrive after a period of complex, confusing evolution, but it will ultimately raise the quality of life for anyone who interacts with any kind of financial services, including customers, employees, shareholders and regulators — which, of course, is everyone.
Balázs Czímer is a partner in Budapest office of McKinsey, where Valéria László is an associate partner; Miklós Dietz is a senior partner in the Vancouver office; and Joydeep Sengupta is a senior partner in the Singapore office. The article was excerpted from the full McKinsey report, which can be downloaded here.