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BirdsEye View

time to run scared - part 2

 The following article from Bloomberg (10-22-19) outlines a McKinsey report that has been circulating across many bank boardrooms around the country.  It was published after I wrote my article, “Time to get Scared”.  I’m sharing this article with you and adding my own notes to it as a follow up to the article I wrote recently. 

“Banks Must Act Now or Risk Becoming a ‘Footnote’: McKinsey 

 By Hannah Levitt

(Bloomberg) -- More than half of the world’s banks are already in a weak position before any downturn that may be coming, according to a report from consultancy McKinsey & Co. 

A majority of banks globally may not be economically viable because their returns on equity aren’t keeping pace with costs, McKinsey said in its annual review of the industry released Monday. It urged firms to take steps such as developing technology, farming out operations and bulking up through mergers ahead of a potential economic slowdown. 

“We believe we’re in the late economic cycle and banks need to make bold moves now because they are not in great shape,” Kausik Rajgopal, a senior partner at McKinsey, said in an interview. “In the late cycle, nobody can afford to rest on their laurels.”

The decade since the global financial crisis has seen a wave of innovation in financial services, bringing new competitors from fintech startups to giants like Apple Inc. and Alphabet Inc.’s Google. Banks have pondered whether to compete with, partner with or acquire some of these newcomers. Some established firms have sought to rebrand as technology companies, in part to attract hard-to-get talent. (AB:  LiveOak is a great example of such a bank). 

McKinsey, whose clients are some of the biggest corporations in the world, consults on topics ranging from strategy and technology to mergers and acquisitions, outsourcing and stock offerings. In its report, the firm said banks risk “becoming footnotes to history” as new entrants change consumer behavior. Most recent attempts by banks to boost efficiency have been “business-as-usual,” it said.

Banks allocate just 35% of their information-technology budgets to innovation, while fintechs spend more than 70%, McKinsey said. Combined with regulatory factors lowering the barrier to entry -- like open banking and looser requirements for startups -- the environment is increasingly conducive for newer firms to take share from banks. (AB:  Only the largest banks allocate a full third of their technology budget to innovation.  Most of you, my readers, spend 85% of your technology budget to keep the wheels turning.  This exacerbates the problem of the supercommunity bank threatened obsolescence – we spend less money in BOTH absolute dollars and relative budgets).

 The report points to Amazon.com Inc. in the U.S. and Ping An in China as examples of technology firms that are capturing financial-services customers. To make matters worse for the old guard, the new players tend to go after the business areas that create the highest returns at banks -- credit cards, for example. (AB:  I con cur this is the case for the megabanks, but dispute the assertion when smaller banks are concerned.  Amazon unquestionably is a huge threat, but supercommunity banking has a different value proposition which marries technology with the human touch.  Humanology is the future of banks which can’t invest as much in innovation, and can be a sustainable competitive advantage if a bank develops a clear strategy on the fit of technology into its delivery and production systems.  What we’re missing is a clear articulation of our expectations from technology, both internally and externally, and how we marry current technology with human delivery and production channels).

Investors have taken notice. Globally, banks’ valuations have fallen 15% to 20% since the start of last year, McKinsey said, adding that “the drop in valuation suggests that investors anticipate a sharp deceleration in earnings growth.” (AB:  While this decline may be attributed to the rate environment, one must nevertheless take heed of the McKinsey warning, as our marketplace and customer base are changing faster than we are).

Lenders can cut costs and find funds for technology by outsourcing what McKinsey calls “non-differentiating activities,” including some trading and compliance functions. Banks “need to get much more comfortable with external partnerships and being able to leverage talent externally,” Rajgopal said. 

Another way to free up money: get bigger. BB&T Corp. and SunTrust Banks Inc. said as much when they announced their decision to combine earlier this year -- the biggest U.S. bank merger since the financial crisis. Rajgopal said he expects M&A to continue in the late cycle.

“Going forward, scale will likely matter even more as banks head into an arms race on technology,” the report says.”

AB:  This report is valid for our entire industry, but more for the largest banks that use technology as their primary delivery channels, particularly to consumers.  Commodotization and innovation continue to threaten our business, but they can also present opportunities to build a bank’s competitive position if clearly understood and universally adopted within the enterprise.  Accepting that the risk of doing nothing is greater than the risk of doing something is the beginning of wisdom in his new era.