Banks face value creation challenge despite record revenues

Declining interest rates and mixed record on productivity growth keep markets skeptical.

Whilst the banking industry hit its best profits since the 2008 financial crisis in the past two years, it now faces the problem of creating value in the long-term.

Only 14% of all banks globally are expected to create value and outperform their peers’ price-to-book and price-to-earnings, according to McKinsey & Company.

Banks logged over $7t in revenue in 2023 and saw net income climb 8% to $1.15t in the same year. This is around the same level as in 2022, according to McKinsey data. This is reportedly the banking industry’s best in terms of profitability since the global financial crisis (GFC).

Liquidity also rose. Loans to deposit ratio was 77.2% in 2023, climbing from 75.5% in 2022, although both are still lower than the 2011 to 2021 average of 78.5%.

But these highs are still not enough to convince markets about the industry’s long-term health, McKinsey said, noting that price to book ratio is 0.9 (below 1 means that markets think the industry is eroding value rather than creating it).

The decline of interest rates may compress banks’ net interest margins (NIM) by 50 to 60 basis points, to roughly 2.7% in 2030. This, in turn, will hit profit growth and ROTEs.

Banks also have a mixed record on labor productivity growth, and face intensifying competition for profitable lines of businesses.

“Despite a global total of [around] $600b being spent by banks on technology that should be boosting productivity, labor productivity in many major markets (such as the US), is declining,” McKinsey said.

They noted the potential of AI to fix this, but that it’s “too early to tell.”

Deposit volumes are down and competition for them is tougher, which could drive costs up, McKinsey said. 

Demand for loans has also declined. Commercial real estate originations in the US, for example, are down 55% from the pandemic peak, and 25% below their 10-year average.