Nearly 60% of the banks in the world might struggle to survive an economic downturn, said McKinsey & Company in its latest global banking review.
"A decade on from the global financial crisis, signs that the banking industry has entered the late phase of the economic cycle are clear: growth in volumes and top-line revenues is slowing, with loan growth of just 4% in 2018 —the lowest in the past five years and a good 150 basis points (bps) below nominal GDP growth," McKinsey noted.
The report also highlighted banks' shrinking returns on equity, which haven't grown in line with their costs.
"The global industry approaches the end of the cycle in less than ideal health, with nearly 60% of banks printing returns below the cost of equity," McKinsey said. "A prolonged economic slowdown with low or even negative interest rates could wreak further havoc."
Most banks are in trouble because of geography, scale, differentiation, and business model," the firm pointed out, adding that differentiated banks might have an edge over their peers.
“The domicile of a bank explains nearly 70% of underlying valuations. Consider the US, where banks earn nearly ten percentage points more in returns than European banks do, implying starkly different environments,” McKinsey noted.
In addition, scale in banking, as in most industries, is generally correlated with stronger returns, the company pointed out.
“Be it scale across a country, a region, or a client segment. Having said that, there are still small banks with niche propositions out there generating strong returns, but these are more the exception than the rule,” the company said.
Underlying constraints of a business model also have a significant role to play, according to McKinsey.
“Take the case of broker dealers in the securities industry, where margins and volumes have been down sharply in this cycle,” said McKinsey. “A scale leader in the right geography as a broker dealer still doesn’t earn the cost of capital.
McKinsey advised banks to make "bold late-cycle moves" such as expanding their offerings to avoid collapsing when the next recession hits.
"In China, Ping An has built an ecosystem that includes healthcare, automotive, entertainment, and tourism services, while in the US, Amazon offers businesses the traditional banking suite (that is, current accounts, credit cards, unsecured loans), while connecting them to the Amazon ecosystem, which includes non-financial products and services," McKinsey said.
The consultancy also advised banks to invest to stay competitive and they can also form partnerships through M&A to stay afloat.
Fintech firms are organizations with which banks can strike deals to improve their technology and scale.