McKinsey warns that while a favourable wind has returned to the banking industry’s sails of late, the path ahead remains fraught with challenges and uncertainties
In recent years, the banking industry has embarked on a tumultuous journey, navigating treacherous waters marked by increased oversight, digital innovation, emerging competitors, and historically low interest rates. While a favourable wind has returned to the industry’s sails in the past 18 months, the path ahead remains fraught with challenges and uncertainties, according to a new report by consulting firm McKinsey.
Regulatory oversight
One of the most pressing challenges the banking sector faces is the ever-evolving landscape of regulations and oversight. Regulatory authorities have tightened their grip on financial institutions, demanding greater transparency and accountability. This increased scrutiny has forced banks to invest heavily in compliance measures, diverting resources that could have been used for growth and innovation.
Digital innovation
Digital innovation has also disrupted the traditional banking model. Fintech startups and digital payment specialists have gained significant ground, offering consumers convenient alternatives to traditional banking services. These new competitors leverage technology to provide faster, more efficient, and customer-centric financial solutions, challenging traditional banks to adapt or risk losing market share.
Profitability pressure
The traditional model of borrowing at low rates and lending at higher rates has been strained, squeezing margins and limiting revenue growth. Banks have had to explore alternative revenue streams and investment strategies to maintain their financial health.
In recent months, liquidity woes and bank failures have added to the sector’s challenges. These disruptions serve as a stark reminder of the vulnerability of the banking industry, even in periods of relative stability. Managing liquidity risks and ensuring the resilience of financial institutions will continue to be critical concerns.
Shifting undercurrents
Beneath the surface, significant shifts are occurring within the banking sector. Traditional banks are facing increasing competition from non-traditional institutions and capital-light market segments. Digital payment specialists and private markets, including alternative asset management firms, are capturing a growing share of financial transactions and assets under management. This diversification of the financial landscape is challenging the traditional core of the banking sector—the balance sheet.
The movement of assets away from traditional banks and into alternative institutions is reaching a tipping point. This shift requires a re-evaluation of how we define the banking sector, broadening its scope to include all financial institutions except insurance companies. As banks adapt to this changing landscape, they must grapple with the implications of a fragmented financial ecosystem.
Succeeding in the Great Transition
In an era characterised by unprecedented technological advancements, shifting regulations, evolving risks, and the imperative of scale, financial institutions find themselves at a crossroads. The Great Transition, as it is being termed, demands strategic re-evaluation and adaptation. To thrive in this ever-evolving environment, banks must prioritise and embrace transformative changes. Consulting firm McKinsey prescribes five key priorities that can serve as a blueprint for banks looking to capture the moment.
- Embrace Technology and AI:
The financial sector is undergoing a digital revolution, and banks must be at the forefront of this transformation. Leveraging technology and artificial intelligence (AI) can significantly enhance productivity, talent management, and the delivery of products and services. Applying AI and advanced analytics to automate processes, develop platforms, and foster ecosystems is crucial. Banks should take a cue from tech companies and cultivate a cloud-based, platform-oriented architecture. In the competitive landscape, distinctive technology development and deployment will become a critical differentiator for banks.
- Flex and Unbundle the Balance Sheet:
Flexibility is key to surviving and thriving in the Great Transition. Banks must actively explore syndication, originate-to-distribute models, and third-party balance sheets, such as banking-as-a-service applications. Unbundling, which can be undertaken in stages, involves separating customer-facing businesses from banking as a service. Technology plays a pivotal role in radically restructuring costs, ensuring that banks remain agile and adaptable.
- Pursue Scale or Exit Transaction Business:
Achieving scale in specific markets or products is essential for success. Banks can either go deep into a niche or aim to cover an entire market. Pursuing economies of scale in transactional business through mergers and acquisitions can be a game-changer. Collaborating with partners to facilitate exits is another viable strategy, ensuring that banks remain competitive and relevant.
- Elevate Distribution Strategies:
The distribution landscape is evolving rapidly, and banks must adapt to changing customer preferences. An integrated omnichannel approach, combining automation and human interaction, is paramount. Embracing embedded finance and marketplaces, along with digital and AI-based advisory services, is vital. Crafting a strategy for third-party distribution through partnerships can open new avenues for serving customer needs and expanding beyond existing business models.
- Adapt to Changing Risks:
The risk environment is in a constant state of flux. Banks must remain vigilant in the face of evolving macroeconomic, regulatory, and cybersecurity risks. Elevating the risk function and embedding it in day-to-day activities is essential. Banks should emphasise their resilience in managing systemic risk and liquidity, demonstrating their ability to navigate uncertainty effectively.
The Great Transition presents both challenges and opportunities for financial institutions. To thrive in this dynamic landscape, banks must prioritise technology, flexibility, scale, distribution, and risk management. Capital plans must align with these strategic priorities, ensuring that banks are positioned to generate adequate returns. As technology and data increasingly drive scale, the gap between winners and losers in the financial sector is set to widen. The time to chart a forward path is now, and banks must act decisively to capture the moment and secure their place in the future of finance.