Banking cull continues as profits rise

Off-balance sheet income is driving global banks’ Q3 earnings, a McKinsey report has found, but to sustain growth momentum, Asia’s institutions will need to overhaul inefficiencies.

Rising interest rates have contributed to an improved performance by financial institutions over the past 18 months, a report published this month by McKinsey & Company, has revealed. However, in the context of heightened competition from nontraditional players and the emergence of private financing channels, the need for banks to pursue cost improvements where possible, has become increasingly vital.

The consultancy firm’s 2023 review of the global banking industry, titled “The Great Banking Transition”, highlights how interest rate hikes – and their consequential impact on improved net interest margins – have led to topline growth across banking sector profit, with 2023 results landing  $280 billion above achieved profit for 2022.

The research also predicts that institutional return on equity (ROE) is expected on average, to breach 13% in 2023, compared to an average of 9% for the 2009 to 2023 period.

In spite of protracted global uncertainty that has seen recent renewed conflict and despair ripple across the Middle East, continued combat in Ukraine, and political instability globally; financial market volatility has offered some upside for the institutional space.

 “2022 was the best year for many in more than a decade as higher interest rates ended a years-long trend of margin compression and 2023 is expected to end on a similar note,” Renny Thomas, senior partner, leader of Asia Pacific (Apac) banking and securities practice at McKinsey, told FinanceAsia.

These findings come as big players release their third quarter (Q3) earnings.

This month, Citigroup posted a 9% year-on-year (YoY) increase in revenue and a 2% rise in net income; while its Institutional Clients Group (ICG) reported 12% YoY growth, which the bank attributes largely to higher interest rates and deposit volume growth.

Meanwhile, Bank of America (BofA) reported a 10% increase in net income and 3% rise in revenue on 2022 activity. The bank’s Q3 net interest income (NII) finished up at $14.4 billion, up by $614 million on the previous year. Data compiled by Bloomberg suggests that this constitutes BofA’s best Q3 performance in more than a decade.

However, Thomas warns that banks should not become complacent. “While in near term, there appears to be a sense of stabilisation and cautious optimism, despite recent upturn in performance, gains in NII might not sustain if and when interest rate hikes slow and ultimately reverse,” he said. 

Revenue shift

The McKinsey research suggests that banking revenue has shifted to off-balance sheet (OBS) earnings, Thomas told FA.

He explained that, although the notion of OBS growth in assets under management (AUM) is not new, we may be approaching a tipping point.

He cited figures from the report indicating that more than 70% of the net increase in financial funds between 2015 and 2022 were recorded OBS and held by alternative investment players, including pension funds and sovereign wealth funds. Moreover, private debt and equity has grown at a compound annual growth rate (CAGR) of 20% in the same period.

“The migration has been taking place for two decades post-global financial crisis (GFC) in 2008, as banks have faced higher capital and regulatory responsibilities,” Thomas said.

He added however that private financing channels have equipped investors with speed, flexibility, convenience and the ability to higher risk-reward opportunities.

“As banks continue to optimise their balance sheets and customers search for higher returns, this trend is likely to continue in future.”

Operational efficiency

Transactions and payments are also shifting, the report suggested, as the number of digital payments processed for consumers through payments specialists grew by more than 50% between 2015 and 2022.

Banks face increasing competition from nonincumbents that are less constrained by legacy systems and cost overhang, Thomas noted.

“Given this backdrop, financial players are increasingly competing on the basis of technology to help enable scaled delivery and reduce costs,” he said, pointing to the banking sector’s cost-to-income ratio (CIR) dropping from 59% in 2012, to 52% last year. Thomas emphasised the importance for banks to continue to improve operational inefficiencies and reduce costs.

Overhauling operations and driving efficiency are considerations that appear to be top of mind for global banks, as Citigroup, Bank of America (BofA), Credit Suisse under UBS, and Morgan Stanley, pursue restructuring and retrenchment plans through potential layoffs, resulting from market uncertainties in the past year. In September, Citi’s CEO, Jane Fraser, was reported to have communicated plans for the bank’s largest downsizing in two decades. It is anticipated that a full list of cuts will be compiled by November.

In terms of best-performing geographies, the report noted the performance of banks located in the Indo-crescent region (markets around the Indian Ocean) stood out from their peers based in other parts of the world.

The area, which includes markets such as United Arab Emirates (UAE), India, Vietnam and Thailand, is home to half of the best-performing banks globally, according to the report. Meanwhile, in Europe, the US, China and Russia, “banks, overall have struggled to generate their cost of capital,” it detailed.

“The superior performance of Indo-crescent is enabled by several factors, including favourable demographics, better industry structure and less legacy on technology and other factors,” Thomas told FA.

He added that broader economic growth and the development of digital infrastructure in certain markets are also contributing to this uptick.

Finally, the report identified five key trends Asia-based institutions should pay attention to. These include the rise of artificial intelligence (AI); the need to optimise balance sheet use; payments and transaction businesses; integrated omnichannel distribution; and macro, cyber and geopolitical risk capabilities.

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