Report after report, expert after expert confirms what common sense tells us: Fundamental change must occur for financial firms to secure a profitable future.
"The large banks will need to rethink each business line, each product, each geography — everything. The strongest survivors will turn themselves inside out over the next five years."
I wrote that nearly two years ago. And what's happened since? Not enough.
To be sure, bank balance sheets are stronger, capital ratios are higher, problem loans have been whittled and marginal businesses are memories for many companies.
But revenues remain below pre-2007 levels, investors are discounting bank stocks and very few companies have found a sure path to sustainable growth.
What are bank CEOs waiting for? Economic recovery is not a sufficient answer. Hope is not a strategy. Change is coming and bankers have a choice — get in front of it or get left behind.
"We are running to keep in place," Toos Daruvala, a McKinsey & Co. director, says to describe the industry over the last few years. "We've just pushed out, if you will, the timeframe for when the industry gets to its 'new normal' and starts earning the returns that are more like the 10% to 12% that it is needed to earn the cost of capital."
With returns closer to 7% today, the industry has a long way to go.
Simplification is the key to what ails the largest banks. And while much of the Dodd-Frank Act may eventually force systemically significant banks to streamline themselves, it's a good bet the market will beat regulators to the punch.
"The largest, most diverse and most complex institutions … certainly will not get bigger. They may well get smaller," says Daruvala. "I suspect it will be less regulatory pressure and more investor pressure and performance pressure.
"There are only so many years when you can move along at 0.6 or 0.7 [times] price to book. I think we have another couple of years. The pendulum will hit the other extreme in two to three years, and if banks haven't solved their issues by then, I think there will be some further action by investors."
Put more bluntly: Shareholders will force divestitures or even break ups.
Banks that prefer more control over their destiny might want to read Daruvala's latest study. "The Triple Transformation" is McKinsey's latest attempt to grab bank executives by the lapels and get them to focus on the future.
According to McKinsey, the economics of everything a bank does needs to be rethought. Business models must be revamped. The culture has to change.
All three are equally important, but some banks need more work in one area versus another, Daruvala says.
Let's take them one by one.
First, the "economics of banking" comes down to deploying capital smarter and finding ways to build revenue.
"Banks need to take a much more granular look at what they are doing on the balance sheet, given capital ratings," Daruvala says. "Frankly, banks have to take off the rose-colored glasses and don't just hope that the ROE in a line of business is going to come back to what they used to be, but really look hard at what is the bank capable of achieving in that line of business."
On the revenue line, banks have to think about pricing and new pockets of growth.
"In a world in which you've got really compressed net interest margins, given the low-rate environment, you've got to be looking at fee income as alternative sources," Daruvala says. "I think this is really a conundrum. … What are you going to be able to do, given the regulatory reality and given the competitive reality, from a pricing and a fee-income standpoint?"
McKinsey says banks must get customers to pay for the products and services they value. One example might be online banking. It's widely free and yet it is clearly a product customers love.
"Are there other sources of value-added services that banks are providing that consumers would be willing to pay for in fully transparent, disclosed ways?" Daruvala asks. "I don't think banks have done that."
Daruvala offers up the airline industry as an example of the sort of wholesale change McKinsey thinks is necessary. "The way airlines price today is hugely different whether it's a fee for a second bag or extra legroom or an aisle seat."