The digital revolution sweeping through the banking sector is set to wipe out almost two-thirds of earnings on some financial products as new technology companies drive down prices and erode lenders’ profit margins.
This is one of the main predictions by the consultancy McKinsey in its global banking annual review to be published on Wednesday, portraying banks as facing “a high-stakes struggle” to defend their business model against digital disruption.
McKinsey said technological competition would reduce profits from non-mortgage retail lending, such as credit cards and car loans, by 60 per cent and revenues by 40 per cent over the next decade.
It predicted a smaller, but still significant, chunk of profits and revenues would be lost from payments processing, small and medium-sized enterprise lending, wealth management and mortgages. These would decline between 35 and 10 per cent, McKinsey said.
Philipp Härle, co-author of the report, said: “The most significant impact we see is price erosion, as technology companies allow delivery of financial services at a fraction of the cost, and this will mostly be transferred to the customer in lower prices.”
He said most technology companies were focused on picking off the most lucrative parts of banks’ relationships with their customers, leaving them as “dumb” providers of balance sheet capacity.
“Most of the attackers do not want to become a bank,” said Mr Härle. “They want to squeeze themselves in between the customer and the bank and skim the cream off.”
McKinsey said banks last year made $1.75tn of revenues from origination and sales activities, on which they earned a 22 per cent return on equity, while they made $2.1tn of revenue from balance-sheet provision at a return on equity of only 6 per cent.
The consultancy said the industry had two choices. “Either banks fight for the customer relationship, or they learn to live without it and become a lean provider of white-labelled balance sheet capacity,” it said.
While predicting upheaval in the future, McKinsey said there was no evidence that digital disruption had started to eat into banks’ market share yet. Banks’ share of global credit provision has been constant over the past 15 years.
Mr Härle said one factor that could slow down the erosion of banks’ market share was if regulators decided to clamp down on the disrupters by imposing similar capital and compliance rules as those faced by banks.
McKinsey calculated that profits from all banks reached a record of $1tn last year, helped by rapid growth in Asia and particularly in China and as US lenders rebounded from the financial crisis. The average return on equity was stable at 9.5 per cent, as cost-cutting offset falling margins in the low interest rate climate.
Almost two-thirds of developed market banks and a third of those in emerging markets earned a return on equity below their cost of equity and were valued below their book value.
“Many in the industry are waiting for an interest rate rise or some other structural lift to profits, but even if rates rise, that will be insufficient to fundamentally improve economics,” McKinsey said. “We expect margins to continue to fall through 2020, and the rate of decline may even accelerate.”