Annual Review of Global Banking: The State of the Banking Sector in the Year Coming to a Close

A new study by McKinsey & Company titled ‘Annual Review of Global Banking‘ addresses the state of the banking sector in the year coming to a close. The last two years have been the best for banking since the period before the global financial crisis of 2007 to 2009, with high levels of profitability, capital, and liquidity recorded. However, although banking is the largest sector in the world in terms of profit generation, the market remains skeptical about long-term value creation, placing the banking sector last in terms of market-to-book value ratio.

In addition to macroeconomic factors, there are also some industry-specific factors affecting banking:

• In 2024, labor productivity growth in banking was uneven, although banks spend the largest share of their revenue on technology compared to other sectors.
• Regulatory changes worldwide continue to require additional investments.
• The most profitable segments in banking face competition from focused challengers (including private equity, payment services, and asset management).
• The recent increase in business has largely been supported by rising interest rates.
• Despite recent value creation, the sector has diminished economic value over the last decade when measured against the cost of capital.

The question arises whether the surge in overall banking sector results achieved in 2023 will yield to the gravitational pull of the sector’s recent history as new challenges emerge. Observing banks that have performed better over the past five to ten years may hold the answer to how banks could achieve better results. Top-performing banks utilize a combination of moves across three structural dimensions (careful segment selection, finding scale where it matters, and strategic positioning, whether geographically or in the value chain) and rigorous operational execution across a range of capabilities (e.g., analytics, marketing effectiveness, operational model, and technology).

The good news for the rest of the industry is that things can improve. About 10 percent of the industry has improved performance over the past five years. Significant variations in the industry between subsectors and geographical areas can distort how certain institutions are viewed relative to others. Structure and combination could significantly affect how individual banks perform in the future as conditions change. In some countries, including the United States, the United Kingdom, India, Germany, and Nigeria, performance improved in 2023 compared to the period from 2010 to 2022, while other countries, such as Brazil, Canada, China, Japan, and Australia, recorded lower performance.

The Role of Artificial Intelligence and the Future

Banks may not be able to rely on increased productivity or resource utilization. These remain puzzles for banks in many regions of the world. AI (artificial intelligence) has not yet proven to be a panacea (although some leading banks that were early movers have recently publicly announced the effectiveness of AI – for some of them in the billions of dollars). Despite a global total of around 600 billion dollars that banks have spent on technology intended to increase productivity, labor productivity in some large markets (for example, in the United States) is declining. Artificial intelligence could change this, but in most banks, it is still in pilot mode. With this comes increased spending and more regulatory requirements, so many banks have taken a cautious stance.

As described in last year’s report, about two-thirds of the growth in the value of financial assets was in off-balance-sheet assets (e.g., mutual funds and alternatives). Non-traditional competitors such as non-depository companies, private equity, and well-funded neobanks are targeting the largest profit pools.

It is expected that a total of 14 percent of banks will create value and operate at a high level, while about 62 percent of public companies outside of banking achieve the same threshold. The good news is that higher performance is increasingly distributed across the industry (perhaps supported by the regulated nature of different markets). Today, 14 percent of banks generate 80 percent of the economic profit in the industry, which is an increase from 11 percent in 2013. This figure is nearly five times higher than the average of all other industries, where performance is far more concentrated among a few players.