Banks Face ‘Tipping Point’ as Funds Shift Away, Warns McKinsey Report
According to McKinsey & Co.’s annual review of global banking, traditional banks are at a critical juncture as financial funds continue to migrate away from their balance sheets to nonbank institutions. This shift has reached such magnitude that it threatens to fundamentally transform the banking industry. McKinsey’s report states that between 2015 and 2022, over 70% of the net increase in financial funds bypassed U.S. banks and ended up with insurance and pension funds, sovereign wealth funds, private capital markets, and retail and institutional investors. This trend, which has been ongoing for years, has now escalated to an exodus.
While banks have been enjoying their highest profits in over a decade, McKinsey’s report warns that there are underlying challenges. The consulting firm argues that banks must adapt to the changing landscape to remain relevant and profitable amidst technological, macroeconomic, and geopolitical risks.
McKinsey’s report highlights two main threats facing banks. Firstly, the shift of funds away from bank balance sheets, and secondly, the evolving landscape of transaction operations such as payments and trading, which are increasingly being conducted by payment specialists rather than banks.
To address these challenges, McKinsey suggests five strategies for banks to reinvent and future-proof themselves:
1. Embrace technology, including artificial intelligence, to improve efficiency and enhance products.
2. Adapt to risk by strengthening internal risk functions.
3. Flex and leverage their balance sheets by exploring syndication or third-party balance sheets.
4. Expand distribution channels, including AI-based advisory services, to reach a broader customer base.
5. Scale transaction businesses or consider exiting if scaling is not feasible.
According to Alexander Edlich, a senior partner at McKinsey, banks must decide where they want to focus their efforts and who their target customers will be. The ability to navigate these challenges will determine their long-term success.
Jo Ann Barefoot, CEO of Alliance for Innovative Regulation, suggests that banks need to carefully evaluate which business lines they can compete in and consider partnering with scale players or exiting certain sectors. Even smaller banks must consider the future of their balance sheets and strategically invest or divest in businesses.
This is a critical time for all banks to assess their return on investment and strategic choices. The evolving landscape necessitates a proactive approach to remain competitive in the industry.
