The financial services industry is surviving the economic ravages of COVID-19 better than expected, but banks are quickly splitting into “rock star” performers and poorly performing laggards. Welcome to the great divergence!, stated McKinsey & Company.
McKinsey & Company, a global management consulting firm, examines how banks fared in the whirlwind of 2020; details the factors that will influence their economic fate in the coming years (such as geography, customer base, scale, and business model); and looks at the forces lifting one set of banks above the rest.
In the 11th edition of McKinsey & Company Global Banking Annual Review 202 report released on December 2, 2021, the financial services industry is said to be trading at 1.3 times equity book value globally while in Africa banks ate trading at 1.0 times, Nigerian banks are trading at 0.4 times equity on the books. See key findings below.
Key 2021 report findings include that:
- Financial services as a whole (including banks, fintechs, and specialists) is trading at 1.3 times equity book value globally, well below the remaining sectors at 3.0 times book value. Globally and in Africa, banks are trading at 1.0 times, while Nigerian banks are trading at 0.4 times the equity on their books.
- Payments specialists, exchanges, and some securities firms captured more than 50 percent of the $1.9 trillion in market cap that the industry added globally.
- The gap between the banking industry’s leaders and laggards, as measured by total return to shareholders (TRS), has steadily widened. In Africa, TRS for the top-quintile performers was 159 basis points higher than the bottom quintile in 2021. This gap has tripled in the past ten years, with most of the divergence happening in the past four years.
The analysis shows that there are four primary sources for the divergence. The first three—geography, scale, and segment focus—are difficult for banks to change. The fourth—business model—is well within banks’ power to adapt, and our analysis found that banks with capital-light and specialized businesses focused on fees typically thrive. Weak performers can catch up, but time is short. Two-thirds of the value generated (valuations/market cap) during an entire economic recovery cycle is created during the first two years after a crisis.
“In Africa, average banking return on equities (ROEs) dipped from 15 percent in 2019 to 9 percent in 2020, a steeper fall than global ROEs. The industry is set for a recovery that could put African banking ROEs at between 13 and 15 percent by 2025. In Nigeria, average ROEs dropped from 20 percent to 18 percent between 2019 and 2020, and are expected to recover to between 19 and 21 percent,” said Mayowa Kuyoro, a Partner in McKinsey’s Lagos office.
Overall, fintechs and specialized financial-services providers—in payments, consumer finance, or wealth management—are generating higher valuation multiples than most global universal banks. This is no different in Africa. Over the last 12 months, we have witnessed some of these institutions achieve valuations that have been higher than universal banks. Some fintechs are going from a rough sketch to billion-dollar valuation in a few years.
There is a significant competitive advantage linked to scale. In Africa, the top three largest banks in each country are on average 10 points more cost-efficient than the rest of the market. Banks often can’t change their geography, scale, or segment, but the business model they adopt is in their control. Yet many traditional banks have pursued a commoditized universal bank business model based on retail deposits and corporate lending.
According to the report, African banking is now more profitable, and revenues are expected to grow faster than the rest of the global industry with an average growth rate of between 7 and 9 percent.
“We are seeing an accelerating divergence of returns between top and bottom African banking players,” said Francois Jurd de Girancourt, Head of McKinsey’s Banking Practice in Africa. “Winners are benefiting from the great divergence in three ways: (i) by focusing on customer ownership—leveraging technology to increase contacts points and leveraging customer data to personalize offers; (ii) by growing the fee part of the business on the continent—leveraging consumer and merchant payments, corporate transaction banking services and wealth products; and (iii) by deploying the balance sheet outside of their traditional customer base—lending to the unbanked/low-data consumers and SMEs, and offering new products, e.g., through apps and wallets.”
The next few years are crucial for any African bank with aspirations to land on the right side of the divergence described in this year’s report. Not only is there simply no value to waiting, but also history shows a pattern in which institutions that take bold steps toward growth in the first years after a crisis generally hold on to those gains for the longer term.