Global banking facing 'anaemic' revenues a decade on from financial crisis

15 November 2018

A new study has found that banking revenues across the world have collapsed since the global financial crisis, as industry growth is running at less than half the historical average. UK banks in particular have struggled to recover their former size, with much of it having been linked to the nation’s property bubble pre-2008.

A decade has passed since the 2008 global financial crisis, but the banking sector is yet to recover its size from before the first great economic crash of the 21st century. According to a recent study by Accenture, in 2005, there were 24,000 players in the worldwide banking industry; however thanks to an exit of some 8,300 players – contrasting with an arrival of 600 FinTechs, 1,900 payment institutions, 700 banks licensed after 2005, and 400 subsidiaries of incumbent banks being created in a bid to separate risk at major financial players after the 2008 global crash – 19,300 banking sector players exist now.

Now, another analysis from global management consultancy McKinsey & Company has suggested that the revenues of banks have also declined drastically compared to last decade. McKinsey found that investment banks made revenues of $275 billion last year, a figure that stood at $345 billion in 2007. According to the firm, this is because the majority of banking entities have struggled to increase their return on equity, which helps measure profitability, since the crisis.

On avarage, Europe's private investment recoveries are running late by historical standards

The global figure has lingered around 8% or 9% since 2012, thanks largely to the performance of US players. Last year, the average return on equity for European banks was especially bad, dipping to 5.6%, according to figures from the European Banking Federation. This is the highest figure for European financial institutions since 2007, but still stands at less than half of the pre-crisis high of 10.6%. At the same time, disruptive entities in wealth and asset management and corporate and commercial banking have grown significantly, further constricting investment banking’s revenues.

Meanwhile, private investment saw another large drop thanks to busts in the construction and real estate arenas. The UK and Spain saw the largest individual falls in this regard, with more than 50% of their respective tumbles related to construction and real estate. This was largely thanks to an unsustainable property market which ballooned in the years approaching 2008, and McKinsey noted that a return to this would not necessarily be expected or desired. However, it does leave banks with a conundrum as to where else to make these figures back from.

The report comes amid a growing number of investment banks, including UBS and Credit Suisse, taking painful decisions to pull back from business lines that required a large capital commitment in the past six years. According to McKinsey, this is partially because of regulations which have come in to bind banks and prevent them from returning to the alleged ‘gambling’ that led to the financial crisis. Commenting in the report, McKinsey called the industry’s growth numbers “anaemic” before stating that it was undoubtedly “safer, but stuck in neutral.”

GIIPS and the United Kingdom accounted for more than 75 percent of the private investment fall; construction and real estate dominated

Commenting on the findings, Miklos Dietz, a Senior Partner at McKinsey, and co-author of the report, said, “Growth for the banking industry continues to be muted. Industry revenues grew at 2% per year over the last five years, significantly below banking’s historical annual growth of 5 to 6%... Compared to other industries, the return on equity of the banking sector places it squarely in the middle of the pack.”

From an investor’s position, he added, this uncovers a “jarring displacement.” Banking valuations have traded at a discount to nonbanks since the financial crisis, standing at 53% in 2015. Two years later, however, regardless of steady performance by the banking sector, it had only seen minor improvements at 45%. Dietz expanded, this means “the banking sector’s price-to-book ratio was consistently lower than that of every other major sector over the 2012-17 period — trailing even relatively sluggish industries such as utilities, energy, and materials.”

Interestingly, perceptions of the current state of banking seem to be pushing a growing number of young professionals away from the industry. Junior banking professionals are considering shifting to the world’s largest strategy consultancies, with MBB firms including McKinsey being the chief beneficiaries of worries among junior staff. According to a recent report, one junior staffer of a noted Swiss bank summed up the situation by commenting that many are looking around wondering “how screwed they're going to be in a couple of years' time," as they worry about the longevity of their job in an investment bank when costs are being cut.


The business and operating models of digital-only banks

04 April 2019

In recent years, several digital-only banks have successfully managed to nestle themselves in the banking landscape, with their popularity continuing to increase. Looking at it from the customer’s point-of-view, there is little difference between these FinTech unicorns; looking at the bigger picture, however, reveals significant variation in their business models. Matyas Fekete, a consultant at KAE, explores some of the main similarities and differences in digi-bank business and operating models. 

What about the profit?

Unlike in the UK, in most of continental Europe, bank accounts and corresponding banking services are historically paid-for services. The fact that digital banks offer most of their services free of charge has undoubtedly helped them build a large customer base. On the other hand, despite comparatively low set-up and minimised operational costs compared to that of traditional banks, and given the lack of revenue stemming from the typically no-fee model, profitability has proved difficult to achieve. Monzo, for instance, recorded a net loss of £30+ per customer in its most recent financial year. 

In the start-up world, it is customary to focus on expansion rather than profit – see the case of Uber, for instance. Still, while profitability might not be their number one priority in their early stages of development, it must be a long-term goal of any business. With their ever-growing customer base, digital banks are increasingly under pressure to turn their business from loss- to profit-making. 

Credit where credit is due

Digital banks pride themselves on their fair (often meaning “free”) proposition and have so far stayed clear of offering loans (including credit cards & overdrafts), traditionally amongst the most lucrative products for traditional providers. Though somewhat reluctantly, newcomers are also realising that offering lending products is one of the most straightforward ways to offset losses made on their free, often high-cost services (e.g. overseas ATM withdrawals). Monzo, N26 and Starling have recently started offering credit products to their customers, with their loan offering expected to be extended to a wide range of services, from mortgages to overdrafts. Correspondingly, creating a lending portfolio can also pave the way for launching an interest-paying savings offering – a proposition seen as a basic banking product that is yet to feature in most digital banks’ portfolios. 

The business and operating models of digital-only banks

The premium customer

While most digital banks offer most of their products for free, some have extended their offering by paid-for premium services in order to create a revenue stream. As these premium features – including different types of insurance, unlimited free transfers/withdrawals, faster payment settlement or concierge services – are often offered in a subscription format, customers are typically prompted to pay for the full package rather than just the desired service(s), providing a significant revenue stream for the bank. Revolut, for instance, was amongst the first digital banks in Europe to break even earlier this year, a feat largely due to revenue from its premium subscription.

SMEs like digital too

Traditional banks typically service small and medium sized businesses under their retail rather than corporate banking arm. Having their product offering tested with consumers, and consequently gaining a reasonable customer base, digital banks have also identified SMEs as an ideal segment to extend their target audience to. The five FinTechs profiled have already gone, or plan to go, down this path by following up their consumer solution with a business account. While both propositions are typically built on similar features, some providers charge businesses a monthly subscription (e.g. Revolut), while others apply additional fees to specific services (e.g. TransferWise), banking on the expectation that businesses are more likely to be willing to pay for banking – something they are already used to doing. 

The marketplace model

While most digital banks offer a wide range of banking services, some of these tend to come from partnering with third-party providers. For instance, Starling Bank’s only proprietary product is its current account, which serves as a basis for the provision of ancillary services, ranging from loans to insurance, to investment opportunities. Instead of developing these services in-house, Starling enables a select group of partnering financial service providers access to its platform in exchange for a fee. In effect, Starling is using its customer base to create a market for its partners, charging a commission for each acquired customer. 

In such cases of digital banks applying this marketplace model, the majority of their income often comes from partners rather than customers. Naturally, only banks with a large enough customer base can be successful in this set-up, underlining the current intensity of competition amongst digital banks.

Banking as a Service

While customer-centricity is heralded amongst the main USPs of digital banks, some are looking beyond offering consumer-facing services to diversify their revenue streams. Starling, which is among the few digital banks built on its own proprietary platform, has recently leapt into the Banking as a Service (BaaS) industry, making its technology available to other start-ups looking to launch a digital bank. Naturally, this raises the question whether the two offerings could threaten each other’s success. Generally, as long as such partners operate in different markets, the two business lines should be able to thrive alongside each other. Further along the line, however, such partners could easily end up expanding their banking solution into the same market(s) as they aim for global success, and by doing so, becoming direct competitors. 

Different approach, same result?

It is fair to say that consumers in Europe looking to bank with a digital-only provider would have a difficult time finding relative advantages/disadvantages amongst the leading players in the industry. Still, despite the limited surface-level variety, exploring the business models of leading digital banks reveals different approaches to the challenge of making money. Alongside the more straightforward method of offering paid-for premium features/subscriptions, some are banking on the value that access to their customer base offers to third-parties, while others outsource their technology to neobanks wanting to focus on the Fin rather than the Tech. With competition amongst digital banks heating up, it will be interesting to see which business model(s) prove to be the winning formula in the long term.