FinTechs and tech giants eye most profitable segments of banks

08 December 2017 3 min. read

Despite having weathered numerous crises over their long history, conventional banks have seen their market share eaten into by new, technologically-savvy competitors in recent years. A new report highlights that banks risk losing out to rapidly proliferating FinTech competition.

The banking system has seen good health return, as the effects of the 2008 financial crisis gradually recede. Many now have robust capital buffers, while cost cutting measures have taken effect. The financial crisis resulted in considerable write-downs for banks, while government monetary policy has since placed considerable strain on net interest margins. While non-performing loans have been, or are being dealt with, increased global fortunes have resulted in most banks being able to improve their revenues.

However, a new McKinsey & Company report, titled ‘Remaking the bank for an ecosystem world’, has shown that the rise of FinTechs may come to cloud the sector’s growing fortunes.

Global revenue growth stood at 5.7% per annum between 2010 and 2015, driven largely by banks in emerging economies – Chinese banks saw 16% CAGR in revenues for the period, while Emerging Asia came in at 10.2% CAGR. In Europe and North America, growth has been more subdued – at 1.9% and 2% respectively, while the UK has managed above average 2.5% growth for the period.Global banking revenuesThe latest figures, between 2015 and 2016 highlight a slowdown, however, with a global average of 2.7%, while North America and Western Europe managed 0.9% and 1.1% respectively. The slowdown is attributed by the firm to changes in consumer behaviour in favour of large platforms, as well as new digital entrants – particularly in China.

Revenue growth is not the only aspect of the wider financial picture to see slowdowns, with return on equity in the banking sector taking a hit in key markets. Globally, margins have fallen from 9.6% in 2014 to 8.6% last year. The negative impact arose largely from squeezed margins, capital costs and risk costs, while many regions were buoyed by improvements in cost efficiencies. Falling marginsNorth American banks, while suffering an 4.1 percentage point drop in margins, saw a similar 4.4% percentage point increase in cost efficiencies. In continental Europe, meanwhile, an already squeezed banking system saw return on equity (ROE) fall from 4.2% to 3.7% between 2014 and 2016, primarily because stronger capital risk profiles saw total risk costs decrease. The UK saw margins fall drastically in light of the Brexit decision, among others, with ROE coming down from 3.8% in 2014 to 1.6% in 2016.

Growing risks

While banks have become increasingly resilient to financial shocks and contagion, new competitive force may place pose challenges to incumbent financial services firms,  although uncertainty around consumer borrowing remains. One analysis by the firm suggests that if corporates and consumers shift their business to new tech platforms, at the same rate that they adopt new technologies, then ROE might drop by 4 percentage points by 2025, to a market average of 5.2% ROE.Non-bank attackers target fee-based businessThe firm notes that giants like Alibaba and Amazon in particular will create risks, although blockchain and other FinTechs create risks too. In terms of the kind of business most at risk for incumbents, the more profitable, but lower revenue, fee-based business areas such as transactions / payment, investment banking and asset management / insurance are most at risk. Margins across these areas come in at around 20%, on around 47% of total revenues.

Commenting on the potential disruption, the authors stated, “This will place banks at the next strategic crossroads: As ecosystems emerge, should banks beat them or join them? The odds are seemingly against banks’ ability to get the jump on the world’s most advanced tech companies. But they have some things going for them. When it comes to customers’ decisions about where to place their money, research shows that banks enjoy greater trust than tech companies.”