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Banks worldwide are currently enjoying a record profit windfall – the highest seen since the 2008 global financial crisis, according to analysis by McKinsey & Company. This year, aggregate profits are expected to hit $1.4 trillion, one of the highest figures among any industry on the globe.
The 2023 edition of McKinsey & Company’s annual ‘Global Banking Review’ shows that banks are racking in unconceivable levels of profit given the current economic and geopolitical environment, levels not seen in 15+ years.
Last year, banks globally recorded a $280 billion profit boost to reach a total of $1.4 trillion, and this year, that number is expected to rise by another $100 billion.
Main driver of the tailwinds: an unprecedented series of interest-rate increases by monetary authorities across the world. As banks are slow in passing on interest-rate hikes to consumers, they benefit from the difference between the interest they pay out to depositors and what they make on loans.
In several countries, that gap has now become so large that politicians have criticised banks for not quickly enough passing on benefits to consumers. Several countries have meanwhile gone a step further and introduced higher taxation. Italy has installed an additional windfall profit tax for banks, the Netherlands has increased taxes on share buybacks, while Ireland has increased the levy on banks that had previously received financial assistance from the state.
Yet these tax rises have often been met with resistance. In Spain, the banking sector began legal challenges, while Italy was forced to water down its original windfall tax following fierce criticism of the measures, among several examples.
A short-lived boom?
Banks however argue that they need the high levels of profit to safeguard their capital positions, and invest in costly changes required to navigate a changing landscape. They also highlight that the profit windfall is largely driven by just one factor – interest rates – with long-term fundaments sliding down due to competition, regulation, and more.
Indeed, McKinsey & Company’s report notes that while banks are currently enjoying boom times, several pillars of the sector are under pressure.
“Despite recent positive performance, our analysis suggests that the long-term contraction of global banking margins and return on equity may resume, subject to the longer-term outlook for interest rates. Gains in net interest income could be short-lived and decline again when interest rate hikes slow and ultimately reverse,” said the researchers.
“If the economy softens, the outlook for net margins will deteriorate. Moreover, the recently published proposals for a Basel III endgame are still under discussion, but the requirements to increase Tier 1 capital could substantially affect banks.”
Growing competition is another area of concern for banks. This is most visible in the payments space, where banks have over the years lost a considerable part of their share to specialist payments and infrastructure providers.
The same is true for the wealth management segment. McKinsey’s analysis shows that more than 70% of the net increase in funds between 2015 and 2022 was held by non-bank financial institutions, such as insurance funds, pension funds, sovereign wealth funds, private capital and alternative investments.
“While the growth of assets under management outside of banks’ balance sheets is not new, our analysis suggests that the traditional core of the banking sector – the balance sheet – now finds itself at a tipping point that could fundamentally alter the nature of the industry, the report said.
Notably, these two segments are also among the most profitable in the sector, meaning that banks are losing share in two high-stake segments.
The top performing banks
McKinsey’s report found that there is a quite large spread in the performance of banks. While European banks combined still have the large asset base (around 35% of the total, down from 39% in 2016), most of the top performing banks are now found in the region around the Indian Ocean (McKinsey calls this region the ‘Indo Crescent’).
Financial institutions in countries such as Singapore, India, the UAE, Saudi Arabia, China, Malaysia, Vietnam and parts of eastern Africa – are home to half of the best performing banks in the world, while in Europe and the United States as well as China and Russia, banks have struggled to generate their cost of capital.
“The Indo Crescent is home to 51% of the top-performing financial institutions globally. This superior performance is enabled by several factors, including higher GDP and population growth in some (but not all) of the Indo-Crescent countries. Other enablers of high performance include breakthrough disruptions, ecosystem plays, and cost-efficient service delivery models; in other words, the area has become a testing ground for a deeper reinvention of banking,” McKinsey stated.
However, Chinese banks, with major ones trading at 0.5 times book value, are facing tougher times and have “limited prospects” of achieving higher returns, according to McKinsey & Company.
The consultants concluded with a caution for all banks: “Regardless of the macroeconomic developments, all financial institutions will have to adjust and adapt to the changing environment, especially the trends of technology, regulation, risk, and scale.”
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