McKinsey Says 20% of Biggest Banks May Shrink or Merge

One-fifth of the world’s biggest banks may be broken up or sold as part of a “radical course correction” to boost shareholder returns, according to McKinsey & Co..

The number of global universal banks may drop to fewer than 10 from about 25 as they narrow their focus on products or regions, the consulting firm said in an annual review of the industry released today. Ninety global lenders are generating higher returns by following one of five distinct strategies described by McKinsey, according to the report.

“It’s not as if it can’t be done,” Fritz Nauck, a director at the consulting firm and a co-author of the report, said in an interview yesterday. “It’s about how do the other banks get there or how does this consolidation start to bring the overall industry up in terms of performance.”

Global banks’ return on equity climbed to 8.6 percent in 2012 from 7.9 percent a year earlier, still below the 10 percent to 12 percent average cost of equity, a measure of the minimum return required by shareholders, McKinsey said in the report.

U.S. banks earned an average return of 8 percent last year and European lenders earned 2 percent, excluding those in the most indebted nations such as Spain and Greece, according to the report titled “Breakaway: How Leading Banks Outperform Through Differentiation.”

Online Competitors

Higher capital requirements, slow economic growth and increasing demands by national regulators that have reduced international capital flows and trade have put pressure on banks’ performance, according to the report. New rules such as the supplementary leverage ratio and the emergence of online competitors are also threats, McKinsey said.

The 90 banks that outperformed earned a 15 percent return on equity, or ROE, and their share prices traded at an average of two times book value, twice the price-to-book value of the rest of the 500 banks the consulting firm reviewed.

The five strategies that McKinsey outlined were universal banking, “investment specialists” that have scale in wealth management or payments processing, lenders that offer superior service and can charge a premium, being a leader in a rapidly growing market, and a “back-to-basics” model that features fewer products and lower costs.

More companies will need to pursue the “back-to-basics” strategy by limiting the industries they serve and dropping marginal consumer products such as student and boat lending, Nauck said. U.S. banks such as Comerica Inc. and M&T Bank Corp. have succeeded with lower margins by cutting costs and maintaining a “no surprises” balance sheet, the report said.

‘Rocket Scientists’

“Compensation must be structured to attract people who are suited to delivering the bank’s basic products — fewer rocket scientists and more people who want to sell mortgages and current accounts in a fair and friendly manner,” McKinsey said in the report.

McKinsey alumni have gone on to senior banking jobs. They include Peter Wuffli, who was replaced as UBS AG’s chief executive officer in July 2007 as credit losses began eroding profit; Johnny Cameron, who ran Royal Bank of Scotland Plc’s investment bank until October 2008; Stephen Green, former CEO and chairman of HSBC Holdings Plc; Peter Sands, CEO of Standard Chartered Plc; and Morgan Stanley Chairman and CEO James Gorman.

The industry may also improve returns through takeovers and mergers, as many of the 190 banks that have an ROE below their cost of equity and are trading below book value may look to sell themselves, Nauck said. He cited the consolidation that occurred after the savings-and-loan crisis of the 1980s when the number of lenders fell by half over the next 20 years.

“I don’t think we need to get quite that number, but there will be a stronger industry for clients, customers, banks, regulators, for all constituents if the weaker banks can be absorbed and managed better by stronger banks,” he said.

To contact the reporter on this story: Michael J. Moore in New York at mmoore55@bloomberg.net

To contact the editor responsible for this story: Peter Eichenbaum at peichenbaum@bloomberg.net

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