McKinsey’s Global Banking & Securities practice in a new report, Global Banking Annual Review, has said that African banks are performing above the global average but face a looming reality check as growth slows. It said that scale and geography will be key determinants of future success. The report highlights that the banking industry is approaching the end of the current economic cycle in less-than-ideal health. Nearly 60 percent of global banks are not generating the cost of capital and are trading below book value. Growth in volumes and top line revenues are slowing with loan growth of just four percent in 2017/18 – the lowest in the past five years and a good 150 bps below nominal GDP growth.
The report said “Yield curves are also flattening. And, though valuations fluctuate, investor confidence in banks is weakening once again. Meantime, digital disruption of the entire industry continues unabated. Given indications that the economic situation is likely to worsen in the short-term, banks are approaching the last likely pitstop in this economic cycle and need to rapidly reinvent business models and scale up inorganically”. According to Rogerio Mascarenhas, Senior Partner and Managing Director of McKinsey’s Nigeria office, there is much to play for in Africa. While there are big differences between countries and customer segments, the continent as a whole is predicting growth of 8.5% pa in the banking revenue pool over the next few years – above the global average. However, banks on the continent are not exempt from the challenges facing the sector globally and clear strategic choices will be necessary if they want to survive tough economic times.
“Industry veterans have been through a few of these cycles before – but this one seems to be different. Knowing where to play will be paramount if Africa’s banks want to avoid irrelevance. The difference between the winners and the losers will boil down first and foremost to geography, scale, with differentiation and business model separating best-in-class from other players. Winners typically have at least a 10 percent share of their relevant markets – be it a country, a region or a customer segment.” Although Returns on Equity (ROEs) remain better on average in Africa (15 percent in Kenya, 16 percent in South Africa and 14 percent in Nigeria – against a world average of 8,9 percent), African banks face similar challenges to their global counterparts: lower margins, increased churn, increased competition the entry of new – and non-traditional – players, often encouraged by regulators.
Mascarenhas said these trends are also evident in Nigeria. Even though banks in the country are performing in line with or better than most of their African peers on ROE, revenue growth has decreased from 23 percent seven years ago to -1 percent today. Bank lending growth was at -5 percent in 2018 compared to 27 percent in 2014. The decreases in growth have resulted in a price to book ratio below 1 at 0.81 for the sector. Frederick Twum, Partner, Head of Transformation in Africa and Head of Financial Institutions for West Africa in McKinsey’s Nigeria Office said that in Africa, where there are typically between 15 and 25 banks per country – most of which have a universal banking model – customer choice is a major challenge and banks should focus on segments and products to reach critical size.
“In Nigeria, banks have an existential need for scale and efficiency as lending contracts (-5 percent in 2018) and the market continues to consolidate with tier 1 banks accounting for more than 60 percent of market revenues in 2018, up from 56 percent in 2013. As uncertainty about the economy, exchange rate and risks persist and threats from non-traditional sources increase – including new regulation allowing payments service banks and the forward march of digital solutions in the payments space – banks are going to need to rethink their technology investments and operating model in order to increase productivity, reduce costs, compete effectively and remain relevant to their customers.”
The McKinsey report identifies four bank archetypes based on enterprise strength and market stability, and highlights the levers each should consider to remain relevant: “Market leaders, Represent just over 20 per cent of banks globally and capture almost 100 percent of the economic value added by the entire industry Imperative: Reinvest capital and resources to invest intelligently in innovation and further scale for the next cycle; nearly 25 percent of banks have maintained leadership in challenging markets, including many in Europe; focus on expanding beyond their direct set of customers and products through ecosystem plays and innovation; about 20 per cent of banks have not achieved scale, and are weaker than peers, despite favourable market dynamics.
“Imperative: act promptly to build scale, differentiate themselves and radically cut costs; Challenged banks, just over 35 per cent of banks globally are both sub-scale and suffer from unfavourable markets while imperative urgency is acute. To survive a downturn, their strategic priority is to find scale through inorganic options if full reinvention of their business model is not feasible. The report looks in detail at bold and yet practical levers to materially improve performance and invest for the next cycle; especially those than can be executed within the short span of two to three years that a late cycle typically offers”.
