Global investment banks have been restructuring their business models in recent years, but still greater change is needed in response to “weak profits, high costs and lingering strategic uncertainty”, says McKinsey.
A newly-issued report from the management consultancy, entitled ‘Capital markets and investment banking 2016: Time for tough choices and bold actions’, notes that revenues for the top 10 global investment banks declined for a third successive year in 2015, reflecting lower earnings from fixed income trading.
“The inescapable reality is that the industry’s restructuring efforts to date have failed to produce sustainable performance,” comment the report’s authors. “A more fundamental change is required, based on the realisation that, for most banks, the traditional model of global capital markets and investment banking is no longer an option.”
Banks’ restructuring efforts have been hindered by “persistent and formidable headwinds”, including the “still evolving impact” of the UK’s decision to exit the European Union (EU).
Fixed income, currencies and commodities (FICC) business has been particularly under pressure across revenues, capital charges and costs, reports McKinsey, representing only 46% of total revenues at the 10 top banks in 2015 against 61% five years earlier. “Over the next few years, the FICC business is likely to remain challenged by a combination of structural and cyclical factors,” the report forecasts.
Complying with tougher regulation will impact on costs, but the top 10 investment banks could boost their profitability by 20% to 30% over three years through digitisation, the consultant suggests. Cost cuts are achievable by greater use of electronic trading and outsourcing more activities to digital shared service platforms. At the same time, cloud technology and machine learning could develop new revenue opportunities.
However, “new technologies remain underutilised, and many banks are struggling to make fundamental changes in their operating models and embrace the potential benefits of digitisation.”
The report warns that the sector’s top 10 banks achieved a combined return on equity (RoE) of 7% in 2015; well below their cost of equity, which is estimated at 10% to 12%. Consequently, the industry is destroying value, rather than creating it. Forthcoming regulation threatens to cut the overall RoE in half, if no mitigating action is taken, with market risk-weighted assets rising from US$650bn in 2015 to more than US$1 trillion by 2020 under the incoming rules.
According to Matthieu Lemerle, head of McKinsey’s corporate and investment banking practice, the consequence could be only three to five investment banks retaining the ability to continue as global full-service banks. The others would be forced to focus on their core markets, becoming more specialist, regional players.
“There is a way out of this, but it is a painful way out of it and it is not for everyone,” he said.
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