- McKinsey study: Average return on equity of global banks rises to 13% in 2023; German banks increase to 5.4%
- Growing importance of off-balance sheet financing and investment instruments: Only one in four euros (23%) in Europe still ends up on banks’ balance sheets
- Intense competition: traditional banks are being overtaken by specialists in many cases, increasingly also in traditional balance sheet business
Banks worldwide continue to benefit from rising interest rates. In 2023, the banking industry’s average return on equity is expected to be 13% – a further increase from 12% in the previous year and significantly higher than the long-term average of 9% since 2010. Due in particular to higher interest margins, the sector’s profit is expected to amount to USD 1.4 trillion globally in 2023, doubling since 2017. In the process, institutions generated record earnings totaling USD 6.8 trillion in 2022.
This also increases the average core capital ratio of financial institutions, which reached a ten-year high of 13.8%. This is according to the current “Global Banking Annual Review” by management consultants McKinsey & Company. The return on equity of German banks in 2023 will also be slightly higher than the previous year at over 5.4%, but still below the European average of 7% and well below the global average.
“The positive trend in the profitability of banks worldwide continues this year and institutions are able to further expand their profits,” says Max Flötotto, senior partner and head of banking consulting at McKinsey in Germany and Austria. “Even though German banks are not able to narrow the gap with the global average, they are also seeing an increase in their profitability. In view of the economic uncertainty, declining interest margins and new competitors, banks must continue to invest in digitalization and innovative strategies to remain successful in the future.”
After all, at least in terms of interest margins, a temporary peak may have been reached this year. It will average 66 basis points in Germany in 2023 and could decline again from next year to 56 basis points in 2026. And the valuation gap among banks will also persist on the capital market. For example, according to the study, the average price-to-book ratio of 0.9 in 2022 has remained consistently low since the 2008 financial crisis – despite recent strong results. “Banks are valued 70% lower on average than companies in other industries, while financial specialists such as stock exchanges, asset managers or payment providers are on average,” said Reinhard Höll, a partner at McKinsey and one of the study’s authors. “The valuations on the stock markets reflect the fact that growth in the financial sector is primarily taking place outside the traditional institutions. At the same time, however, they also show the enormous potential if we succeed in developing future-proof strategies.
Shift in assets and transactions changes financial world
According to the study, a key development that is continuously changing the financial world and posing challenges for institutions is the increasing importance of off-balance sheet financing and investment instruments. Examples include the shift from bank deposits to money market funds, direct financing of pension funds and the strong growth of private equity. For example, between 2015 and 2022, more than 70 percent of net global funding inflows did not go onto bank balance sheets. In both the USA (21%) and Europe (23%), only one in four euros ends up on banks’ balance sheets.
In parallel, there is also a shift in market share in transactions from traditional banks to new providers such as payment specialists, brokers, independent wealth and asset managers or fintechs. In payment transactions, for example, specialists have expanded their market share compared with traditional banks over the past few years to 55% in 2022. In the capital markets business, specialized investment banks and brokers are also gaining market share from traditional banks in various products. In equity transactions, they could increase their market share from 44% to 59% between 2015 and 2022, for example. And in wealth and asset management, independent providers not owned by a bank or insurer are also gaining ground. They had an 81% market share of assets under management in 2022, up from 77% in 2017, and trends such as “embedded finance,” or integrated financial services, are likely to continue this trend in the future.
“The shifts in the financial industry require traditional banks to strategize how to grow profitably over the long term,” says Eckart Windhagen, senior partner at McKinsey and co-author of the study. “Innovations will play a crucial role in this. This includes the use of artificial intelligence both in new product and service offerings and for significant efficiency gains, balance sheet flexibility and partnership development, and also strategic portfolio decisions with a shift of resources and active M&A in future fields.”