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Investment banks need another radical overhaul if they want to make money, says McKinsey
Investment banks have failed to find a way to become sustainably profitable in the eight years since the financial crisis and need another radical overhaul, according to consultancy McKinsey.
Despite spending several years cutting costs and shedding staff, as well as witnessing an economic recovery, the average big investment bank still earns a return on equity of just 7pc.
The result compares miserably with pre-financial crisis returns which frequently rose to more than 20pc, and is below the banks’ cost of capital which is typically thought to stand at around 12pc – indicating the investment banks’ models are not sustainable for the long-term.
McKinsey believes that urgent action is needed, or investment banks may have no future: “Progress has been slow, and the longer the situation persists, the less willing capital markets are likely to be to fund CMIB [capital markets and investment banking] businesses.”
Despite banks’ reforms, revenues remain stubbornly low at $282bn in 2015, more than 20pc below the 2007 level of $362bn.
McKinsey's conclusions came after a study which looked at the biggest banks, including Barclays, Goldman Sachs, Citi, JP Morgan, UBS, Deutsche Bank and BNP Paribas.
The banks’ problems have been caused by a range of factors including ultra-low interest rates and tighter regulation.
While McKinsey expects fines and legal bills for misconduct to fade in the coming years, the banks do face ever-tighter regulation which will push up costs and drive down revenues.
“Too many banks continue to wait for salvation from revenue growth based on traditional CMIB business models. After seven years of underperformance, the time for waiting is over,” the consultants said.
“Banks should abandon hope of a cyclical upturn and focus on structural change. In doing so, they must unravel the product linkages that in some cases have served as an excuse for maintaining unprofitable businesses.”
That means cutting more costs and improving services by replacing people with digital systems, as well as using new technology such as the distributed ledger blockchain system and artificial intelligence.
Training better managers and encouraging better behaviour will also help, as well as ensuring every part of the business works towards long-term profits rather than short-term revenue, the consultancy recommends.
McKinsey believes only three to five banks will be able to hold their position as global banks providing all services, down from 10 before the crisis.
The decline in their numbers will leave more business for those which remain, bolstering their profits. The remainder will have to cut back to become either specialised global banks or full-service regional or national banks, profiting from their more niche focuses.
“Their fragmented geographic footprints are often accompanied by the ball and chain of stranded costs and legacy capital exposures,” said McKinsey.
“This in-between stage—with a smorgasbord of different-sized divisions—is value-destroying and often an unprofitable place for a bank to be.”