Banks could roughly double their current valuations and improve price-to-book ratios to 1.25, on average, if they take major steps to boost productivity, a report published on Monday by the Boston Consulting Group (BCG) has found.
The consultancy’s analyst found that implementing measures to promote growth could allow lenders to boost their valuations by $7 trillion over the next five years.
“The largest driver of pessimism about the banking sector has been the significant drop in profitability,” BGC said.
The case for change
The report found that around 75% of bank stocks had price-to-book ratios below 1 in 2022, while price-to-earnings multiples were almost half of 2008 levels. Meanwhile, shareholder returns on bank stocks have lagged those of major market indexes since the crisis, and the gap is widening.
Analysts agreed that, even if banks invest in productivity and radically simplify their businesses, financial entities “are not likely to return to the profitability levels and valuations that existed prior to the global financial crisis”.
In addition to a more challenging economic landscape, banks are currently facing the pressure created by higher capital requirements and increased competition from newer players such as fintechs, BCG said.
Nonetheless, the report finds banks do have an opportunity to earn more than their cost of equity on a sustainable basis, increase valuations, and improve shareholder returns.
“If banks want to win competitively, they must drive toward far-higher productivity and radically reduce the cost of complexity”
BCG
Unlocking $7 trillion
The financial sector is facing a changed landscape, and so BCG believes it must learn to adapt. The change would not only create shareholder value but also drive economic growth and finance the climate transition.
The report advises lenders to make “clear and forceful resolutions” for the new year, with ” a bold agenda that promotes growth, dramatically improves productivity, and makes banks more appealing to investors in order to enable additional capital infusions”.
“In more than a decade since the global financial crisis, banks have still not managed to adjust their business models to reflect the new reality they are operating in,” says Axel Weber, a senior advisor to BCG, former chairman of UBS Group AG, and a coauthor of the report.
“Urgent actions and a bold vision are needed: banks must redefine where to compete, who to partner with, and how to deliver value amid continued and multifaceted disruption.”
Turning banks into tech companies
The move towards a transformation of the banking sector would start with a digital-first delivery concept and a detailed cost-driver understanding. With these tools, BCG believes it is possible to design a zero-based business model that will allow a step change in productivity that is 40% higher than what is considered normal today.
In addition, banks are advised to make portfolio decisions that enhance value. This would look like exiting business lines or reducing capital exposure to low-return asset classes, as well as investing in new areas of strategic growth that possess more favourable levels of return on equity.
“Banks cannot just aspire to be technology companies. They have to be tech product companies that encapsulate the ideas of customer obsession, test and learn, and radical simplicity, along with embracing risk management and compliance as a strength”
Kilian Berz, Vice Chair of BCG’s Financial Institutions practice
In BCG’s view, banks’ dramatically simplified business models must be supported by an actively managed balance sheet, a modern platform operating model, a bold deployment of front-to-back digitization, and a comprehensive reimagination of functions that leverage AI and generative AI.
The new operating model would then help deliver vastly more impact from data and technology as well as help build strategic partnerships and capabilities for competitive advantage. the report finds.
