Banking market: foreign banks beat local institutions

Despite a surge in profitability, German banks are lagging behind foreign institutions and specialist banks on the domestic market. At the same time, the local banks are currently more successful than they have been for a long time. In 2022, thanks to the turnaround in interest rates, they were able to expand their interest income by 15% year-on-year. With a total of EUR 138 billion, last year was even the most successful in a decade in terms of total operating income.

But within the market there are major differences in profitability. It is true that the return on equity of German banks in 2022 was 4%, significantly higher than in previous years. However, institutions from abroad and specialists such as direct banks, consumer credit banks and automotive banks were significantly more profitable than the sector as a whole, with an average return on equity of 10.4%. This is clear from the current study “What better place than here, what better time than now? German banking in 2023” by management consultants McKinsey & Company. Foreign banks and specialists have also been able to expand their market share from 30% in 2010 to 40% in the meantime – especially in high-profit areas such as asset management or corporate loans, where their market share is already significantly higher in some cases.

“Attributing the lower profitability of German banks in an international comparison solely to the general conditions in the German market falls short of the mark,” says Max Flötotto, senior partner and head of banking consulting at McKinsey in Germany and Austria and one of the authors of the study. “The banking sector here must use the financial leeway provided by the good results to make focused investments in the resilience and future viability of business models as well as innovative strategies.”

Declining interest margins and weaker credit demand

This is all the more true, he said, as the tailwind from the effects of the interest rate turnaround is diminishing. According to the study, it may not be possible to maintain the current level of profitability in the long term. This is because banks are already having to offer their customers more attractive interest rates, for example in the private customer business, due to competition. On the other hand, refinancing costs are rising for the banks themselves, resulting in lower interest margins. In view of higher interest rates and rising investment costs, demand for credit has also fallen significantly.

Added to this are the continuing economic uncertainty and the weak economic development in Germany. Depending on the economic scenario, the average return on equity of German banks could fall to as low as 0.5% in 2030 in the worst-case scenario, according to the study – assuming persistently high inflation and a lasting recession.

“Fundamentally, the return of interest rates opens up long-awaited opportunities for banks,” says Eckart Windhagen, senior partner at McKinsey and co-author of the study. “However, in the current market phase after the turnaround in interest rates, the slowdown in demand in segments such as construction or corporate financing, the increase in the cost of funding and rising risks pose challenges for banks. Those that make their own balance sheets more flexible and manage them in an agile manner will gain market share and be successful in the long term.”

Focus on digitization and human resources management

Another key to banks’ profitability, according to the study, is digitization. With the help of digital ways of working and processes, banks can significantly improve their efficiency and reduce costs. For example, the 10% of the best banks in Europe in terms of cost-income ratio spend two and a half times as much on technology as the weakest 10%.

New technological developments are also playing an increasing role. For example, according to McKinsey, generative AI has the potential to significantly increase productivity in the banking industry – especially in the areas of marketing and sales, operations or IT. In addition, the use of generative AI tools could also improve customer satisfaction, reduce the workload of employees, and mitigate risk through better detection of potential fraud.

“From a strengthened position, the banking sector must continue to drive the technological transformation that has started in many areas. If not now, when?” says Reinhard Höll, partner at McKinsey and co-author of the study. “Digitization is becoming all the more important because the issue of staff shortages is also once again an issue in banks.” That’s because 40% of German banks’ employees are already over 50 years old. By 2030, 30% percent of current staff are expected to leave for age reasons. This means that banks also need to rethink their approach to attracting, retaining and developing staff more strongly for work in the banking industry again.