EXECUTIVE SUMMARY
The Banking Industry stands at a very challenging juncture. While interest rate increases have allowed banks to improve profitability and shareholder returns, the core challenge facing most CEOs and boards is their dismal valuations and growth trajectories on both relative and absolute bases. Many banks continue to trade below book value. Shareholder value destruction is everywhere, and investors question banks' ability to deliver sustained return on equity (ROE) levels well above cost of equity and to show fundamental differentiated growth.
The banking sector continues to struggle to adapt to intense regulations, and transformation programs are yet to deliver their promised outcomes and advantages. As economies continue to rebalance, corporations and consumers are reprioritizing investments and spending in an environment of higher borrowing costs. Market disruption is compounded by continued consumer behavior changes centered around how and why they shop, what products they demand and how they engage with businesses across digital and physical channels.
In an environment of uncertainty, we believe that the drive for profitability will separate winners and losers and that boards will take action. Governance matters above all, and boards are accountable to ensure that executive management decision making and transformation programs deliver results. We offer five key themes for bank CEO's and boards to set a clear leadership agenda, make profitable growth decisions and redirect the course of action.
THEME 1: M&A ACTIVITY TO PICK UP INCLUDES A SET OF ACTIONS TO DELIVER INORGANIC PROFITABLE GROWTH. WHILE WE DO NOT EXPECT MEGA MERGERS, WE WILL SEE WAVES OF CONSOLIDATION IN THE MIDDLE MARKET AND INCREASED M&A ACTIVITY IN NICHE TRANSACTIONS.
THEME 2: AS REGULATORY REQUIREMENTS CONTINUE TO INCREASE, BALANCE SHEET OPTIMISATION TO ACCELERATE BRINGS IDEAS TO IMPROVE CAPITAL EFFICIENCY AND MOVE FROM RULE ADHERENCE TO ADVANTAGE.
THEME 3: DIGITAL TRANSFORMATION: TIME TO DELIVER IS ONE EXAMPLE OF SETTING TIMEFRAMES AND ACCOUNTABILITY TO DRIVE RESULTS. THE SECTOR IS TAKING TOO LONG TO MONETIZE BENEFITS OF DIGITALIZATION. OPERATING EXPENSES MUST CHANGE, AND PRODUCT SIMPLIFICATION NEEDS TO BE DELIVERED. PROVIDING ONE CUSTOMER EXPERIENCE ACROSS UNITED CHANNELS SHOULD DRIVE MORE DIFFERENTIATION.
THEME 4: AS RATE INCREASES PLATEAU, REVENUE GROWTH FROM NET INTEREST INCOME (NII) TO FINISH INCLUDES ACTIONS TO DRIVE RESULTS THROUGH ORGANIC GROWTH.
THEME 5: OPERATIONAL RESILIENCE: THE BIGGEST RISK PROVIDES SOME ACTIONS FOR BANKS TO MANAGE DIGITAL AND CYBER RISKS WHILE RATIONALIZING TECHNOLOGY COST AND OPERATIONAL CAPABILITIES.
THEME 1:
M&A ACTIVITY TO PICK UP
Banks face complex business portfolio management decisions. Banks are required to make the choice between inorganic growth for scale or divestment to redeploy capital. We estimate that up to 20% of the business is not profitable enough due to lack of scale or organisational fit and should be treated as noncore. Geographical and income diversification strategies will continue to spur M&A activity. We expect further consolidation in the U.S. banking middle market sector due primarily to regulatory developments. While we do not see pan-European mergers or large global bank consolidation, we expect to see a significant increase in niche transactions to reposition business portfolios and optimize ROE. Payments, wealth, wholesale banking, AI and climate tech will be hot areas of activity. Divestment of non-core countries and sub-scale business will also pick up.
CALL TO ACTION:
01 ACTIVELY PRIORITIZE M&A OPPORTUNITIES TO ACCELERATE GROWTH AND SCALE IN ATTRACTIVE BUSINESSES AND SEGMENTS.
02 EXECUTE STRATEGIC PORTFOLIO REVIEW, IDENTIFY 20% OF THE BUSINESSES LESS PROFITABLE OR SCALABLE AND DECISIVELY EXIT THEM.
03 DEVELOP JOINT VENTURES IN INNOVATIVE CAPABILITIES RELATED TO AI, TATA AND ANALYSIS FOR CUSTOMER ADVANTAGE AND CLIMATE TECH.
THEME 2:
BALANCE SHEET OPTIMISATION TO ACCELERATE
Banks continue to face a valuation gap as investors question sustainability of earnings and discount continued regulatory uncertainty. While ROE has improved due to rate increases, cost of equity has also increased, and few banks are delivering sustained ROE levels above 15%. In addition, new capital and long-term debt requirements in the U.S. will put additional pressure on balance sheet optimization strategies. Banks will accelerate originate-to-distribute strategies and increase focus on increasing riskweighted assets (RWA) velocity. Excessively leveraged balance sheet mismatches can lead to investors requiring a premium on the cost of capital to compensate for business model risk
CALL TO ACTION:
01 ACCELERATE THE USE OF SIGNIFICANT RISK TRANSFER TRANSACTIONS (SRTS) AND REVAMP BUSINESS INCENTIVES TOWARDS ORIGINATE-TO DISTRIBUTE STRATEGIES.
02 ACCELERATE THE USE OF SIGNIFICANT RISK TRANSFER TRANSACTIONS (SRTS) AND REVAMP BUSINESS INCENTIVES TOWARDS ORIGINATE-TODISTRIBUTE STRATEGIES.
03 SYSTEMATICALLY REPORT ON PROFITABILITY OF NEW BUSINESS AND STOCK BY PRODUCT, SEGMENT, CLIENT AND GEOGRAPHY TO ACTIVELY STEER BALANCE SHEET AND COMMERCIAL STRATEGIES..\
To view full article, click here.
January 12, 2024
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
