Alex Cutulenco | Ubika Research Analyst | February 10, 2016: In the wake of the digital revolution and a change in consumer demographics, one industry that is undergoing structural change is banking. With the rise of technology, startups are developing various ways of attracting customers away from legacy banks, and today we examine this fundamental shift.
McKinsey, a highly reputable global consultancy firm, estimates that due to the rise of financial technology firms, the fight to hold onto customer relationships will be a high-stakes struggle for legacy banks, adding that “10-40% of revenues and 20-60% of profits will be at risk by 2025.”
McKinsey points out that global banks ROE is deteriorating to a global average of 9.3%, down from 14% (2002-2007), as seen by Figure 1.
Figure 1: Operating Performance of Banks (across recent time frames)
Source: Thomson Reuters, McKinsey Research
Most of the banks’ losses will come from margin compression as new entrants force prices/fees lower. However, Canadian banks are over performing as compared with its global counterparts, yet are still seeing a decline in ROE. As seen by Figure 2, ROE has been in constant decline since 2012, reaching 13.8% in 2015. Disregarding the economic recession in 2008/09, this level of ROE dates back to 2002/03 levels.
Figure 2: ROE of Selected Canadian Banks
Data represents average ROE of RY, TD, BNS, BOM, CM, NA, HCG, CWB, LB, HSBC, and FC.
Source: Ubika Research, Thomson Reuters
Needless to say, this drop in margins is troubling for banking executives, and the Canadian economy as a whole, as the financial industry represents roughly 25% of its economy. McKinsey expects margins to continue to fall through 2020, with the possible acceleration of the rate of decline. “Persistently low interest rates and the digital-driven commoditization of key banking products, especially credit related, are cutting deeply into banks’ profits,” they note.
Lastly, readers should understand the fundamental challenges facing banks, specifically:
• The bond between bank and customer is typically not strong, making it easy for customers to switch to digital product offerings
• Technology allows for new behaviors that neither banks nor customers can anticipate. As Steve Jobs famously said, “people don’t know what they want until you show it to them.” And FinTechs are definitely driving that creativity.
• The banking industry’s reputation was tainted by the financial crisis
• The next wave of banking customers are millennials – the children of the digital age
• And lastly, FinTechs offer considerable cost advantages over banks, charging as little as 15 bps in asset management, as compared to 100 bps+ that incumbents routinely charge
For more on FinTech, please refer to some of our top stock picks!
Alex can be reach at: alex@gravitasfinancial.com
Read more analyst insights from Alex Cutulenco
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