The crisis of 2008 came from within the financial services industry. Today, in this crisis of the real economy, banks are economically afflicted alongside other sectors in society. But banks are also playing an important role in helping society through the crisis: as the conduit for state support, supporting small businesses, companies and individual citizens.
The crisis is delivering, in effect, the biggest stress test to banks, a test which the industry is withstanding to-date, whilst demonstrating resilience and purpose. The impact of the last year without the role the industry has played is likely much deeper.
Going forward, McKinsey anticipates the test presented for banks by the pandemic will evolve in two stages in the months and years ahead. First will come severe credit losses, likely through late 2021; almost all banks and banking systems are expected to survive. Then, amid a muted global recovery, banks will face a profound challenge to ongoing operations that may persist beyond 2024.
- Depending on scenario, average return on equity globally would continue its decline, from 8.9 percent in 2019 to 4.9 percent in 2020 to 1.5 percent in 2021. At the trough in 2021, ROE would fall to −1.1 percent in North America, −1.8 percent in Europe, and −0.2 percent in developed Asia. ROE would fall from higher starting levels and bottom out higher in emerging Asia (2.6 percent), the Middle East and Africa (MEA; 3.7 percent), and Latin America (5.2 percent); and it would take a smaller dip to 8.6 percent in China.
- African banks enjoyed one of the highest ROEs in the world, however the overall ROE is expected to half at 7.6 percent in next 2 years, while revenues after risk may decline by 15 percent in a muted recovery scenario. In the short term, banks will be affected by cascading credit losses resulting in 50 percent impact on revenues while in the long term, continued pressure on margins and moderate volume growth might dwarf the revenue growth to half of pre-COVID-19 levels.
- The onset of recovery is likely to vary by country as level of provisioning done by banks in 2020 will be a deciding factor if they will see V- or U-shaped recovery. In SA and Kenya, banks have already provisioned highly for potential bad debts while Morocco and Nigeria may continue to increase provisions in 2021 as well.
Francois Jurd de Girancourt, Head of the Banking Practice in Africa said: “The ROE recovery post COVID-19 is projected to be lower compared to pre-crisis levels, unless banks further improve their cost efficiency. African banks cost to asset ratio is 2.3 times higher than the global average and based on our estimates, banks would need to increase their operating efficiency by at least 25-30 percent to converge back to 2019 ROEs.”
Marie-Claude Nadeau, San Francisco-based McKinsey partner and report author said: “Banks will need to act quickly to return to precrisis ROE levels, in a far more challenging environment than the decade just past. The period of zero percent interest rates is being prolonged by the economic crisis and will reduce net interest margins, pushing incumbents to rethink their risk-intermediation-based business models. The trade-off between rebuilding capital and paying dividends will be stark, and deteriorating ratings of borrowers will lead to inflation of risk-weighted assets, which will tighten the squeeze.”
Mayowa Kuyoro, a partner at McKinsey & Company in Lagos, Nigeria said: “In Nigeria, our analysis is that ROE levels are likely to recover by 2024, although they will remain low compared to pre-crisis levels. To proactively manage this, Nigerian banks will need to revisit and interrogate matters of efficiency and productivity to deliver services to more people at lower cost. The rapid shift to digital is clearing the way for banks to ramp up their use of data and analytics to enhance services and reduce costs. For banks that are existing market leaders, now is the time to consider investing in technology infrastructure and talent to expand beyond current customers and products. Equipping employees with the right skills and digital tools, doubling down on digital marketing, and establishing robust digital infrastructure are likely to be key enablers for success in the next normal.”
For the long term, banks need to reset their agenda in ways that few expected nine months ago. McKinsey sets out three imperatives that will position banks well against the trends now taking shape.
- They must embed newfound speed and agility, identifying what worked well in their response to the crisis and finding ways to preserve those practices.
- They must fundamentally reinvent their business model to sustain a long winter of zero percent interest rates and economic challenges, while also adopting the best new ideas from digital challengers.
- And they must bring their broader purpose to the fore, especially environmental, social, and governance issues, and collaborate with the communities they serve to recast their contract with society.