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FRESH TAKES ON BIG IDEAS

The banking system, supported by higher profit margins, has a historic opportunity in the next few years to reinvent its business model—something it needs to do. Despite margins strengthened by elevated interest rates, banking is the lowest-valued sector in the world, trading at a 0.8 price-to-book ratio, while the rest of the global economy trades at 2.7. Price to book reflects the theoretical amount that shareholders would get if all assets were liquidated and all debts repaid. Trading below 1.0 means the markets see the banking system in a negative light.

Clearly, the banking model needs future-proofing. Banks are losing share in the global intermediary landscape to nonbanks, which are cherry-picking high-profitability businesses. One reason banks are trading so low is that they are very complex. Banking is a mix of three things: distribution (branches and sales staff), transactions, and balance sheet management, which measures how banks are transforming deposits into loans and managing credit risk. Distribution and transactions are profitable and require little capital, so they create value. Keeping things on the balance sheet does not create value, so the banking system needs to consider a new approach to balance sheet management.

Banks could consider separating the core balance sheet from distribution and transaction, following a path taken by utilities and telcos. You don’t necessarily have to break up the bank, but by unbundling, you could create more transparency for investors into what the bank is doing. Banks could speed up the metabolism of balance sheet management through faster securitization. Technology, especially AI, can reinvent every layer of banking, making it more cost-efficient. One more thing we can’t forget: risk. Ultimately, the best-performing banks are the ones that get risk right. It’s not just traditional credit risk but also new types, including cyber and geopolitical risks.

Banks today have it tough. They are expected to operate with incredible cost efficiency and robustness; to run the general ledger and balance sheet; to do asset liability management, matching everything; and to never make a mistake. That alone is a huge task. But banks are also expected to focus on innovation and growth and produce personalized services for every single customer. These two sets of expectations create tension.

“The best US banks operate at a cost-to-asset ratio of 200 basis points, while the best European banks can do 70 basis points or even less.”

In the next few years, banks will need to get the basics right and at the same time reinvent themselves. On one hand, they need to be digital and AI-driven, low-cost, and efficient. On the other hand, they need to be visionary, go into new sectors, and create end-to-end customer journeys.

To create powerful customer journeys, banks can really own the customer relationship. This may enable them to understand clients’ needs and serve them more effectively, bringing higher margins and stronger customer attachment. For example, instead of just offering mortgages, banks could help buyers find a home, move in, and finance it. In payments, banks could offer coupons, e-gifting, online marketplaces, and location-based services. For business clients, banks could add a unified, finance- and payment-enabled platform that integrates services including administrative, tax, accounting, business intelligence, benchmarking, and B2B marketplaces.
 
An ideal banking model might involve strategies from different geographies. In some areas of banking, the United States is more advanced, because it disintermediates more and does more securitization. In others, Europe is more advanced, digital, and efficient. The best American banks operate at a cost-to-asset ratio of 200 basis points, meaning they incur costs of two cents for every $1 of assets managed. The best European banks can operate at a cost-to-asset ratio of 70 to 80 basis points or even less. In Europe, the best banks do 70 to 80 percent of their sales digitally. Some European banks can approve a mortgage application within a day. At the best American banks, it still takes weeks to get a mortgage. Asian banks, especially Indian banks, are the stars of how to go beyond banking and discover new avenues and differentiate. They operate almost like tech companies in many ways.

A provocative vision for the bank of 2035 might be a platform of networks—essentially a holding company for a collection of businesses—including e-commerce, payments, consumer lending, real estate, and a truly personalized advisory business, moving beyond financial into insurance, healthcare, and other things. This could be a $1 trillion market cap bank. It would still do everything that banking is doing now—it would still be very heavily regulated and very stable—but it would be unbundled to create value.

ABOUT THIS AUTHOR

Miklós Dietz is a senior partner in McKinsey’s Vancouver office.

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