A $7 trillion opportunity for banks … or is it?

Banks are boring but necessary. Banks are stable, secure, reliant, resilient and shouldn’t innovate or do things that could increase risk to the system. As a result, banks have been here forever and, love or hate them, will never go away.

According to a new report from the Boston Consulting Group (BCG), global banks could boost their valuations by $7 trillion in the next five years, if they take major steps to promote growth and boost productivity.

Bit of a blasé statement, so what’s underneath the covers here?

Well, let’s start with the basics: only banks do banking; no one else does.

Sure, lots of companies do investments, savings, loans, mortgages, payments and trading, but that’s not banking. Banking is a licensed and regulated market, backed by insurance schemes and governmental oversight, that keeps them secure and trusted. Any company that does not have a government-issued banking license is not a bank.

Is that clear?

So then we look at boring old banks and yes, they are meant to be boring, and we see that in all those other ancillary areas of banking they are losing market share at a rate of 1% to 2% per annum. Simon Taylor ranted about this the other day, calling it the Great Erosion of Banking. His reasoning?

• On the surface, large banks haven't had it better in a decade, yet stock prices are eroding
• Banks are becoming less relevant in the financial services ecosystem
• Banks are eroding because they live in a bubble
• Banks are eroding because of their culture like committees and "PMOs"
• They're LARPing* at technology
• They lack genuine customer obsession
• They're terrible at partnerships
• Banks lack a sense of urgency
• And they're not on a "level playing field"

But Simon is not completely negative, as he sees a major opportunity for banks:

• Some banks are already winning by doubling down on what they're great at (but this doesn't apply if you're "universal").
• No amount of tech spend is too little
• Procurement can be a competitive advantage
• Compliance can be a competitive advantage

His conclusion? Partnerships are the win/win we need for a better financial system. Yes and no, but the term partnership is questionable, as it’s not really a partnership. It’s a client-vendor relationship. Ron Shevlin recently summarised this well:

The term “partnership” implies—if not means—shared risk and reward. This isn’t the nature of most bank-fintech relationships, however—banks purchase or procure technology and services from fintechs.

Anyways, this diverges from the core of this blog update, which is bank valuations can increase by up to $7 trillion by 2030. How?

We (BCG) estimate that at least $7 trillion in value can be created. This corresponds to roughly doubling current valuations in the coming five years by taking a fair share of expected growth and improving price-to-book ratios.

That seems a bit airy-fairy to me and, as Reuters reports, bank price-to-book ratios are pretty awful right now.

About 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.

So, how can they turn that around? BCG recommend seven things:

• Defend Primary Banking Relationships with a Holistic, Digital Offering
• Reinforce the Role as Trusted Custodian of Customers’ Financial Well-Being
• Turn Risk and Compliance and Social Responsibility into a Competitive Advantage
• Boldly Embrace the Climate Transition Challenge
• Capture Network Effects and Increase Scale Through Partnerships
• Navigate Strategic Choices in Embedded Finance and Embedded Commerce
• Retain a Hold on Highly Profitable Areas of the Banking Stack

All sounds well and good and reasonable, except when you look at the wider marketplace of start-ups and alternatives. As S&P wrote a few years ago, Adyen “seems richly valued compared to other payment processors. Its ratio of market cap to last-12-months revenues is 12.8x, versus a median ratio of 2.4x for all publicly traded payment processors in the S&P Global Market Intelligence coverage universe. PayPal and Square have ratios of 7.0x and 8.8x.”

A price-to-book ratio of 12 versus 1 … seems like a bit of a no-brainer to me to invest in the fintechs and alternatives, rather than in banks and boring. Having said that, we need banks and boring, as they are licensed and trusted for those licenses. So what we really need is banks to integrate fintech and become more efficient. Working with fintechs to lower banking costs and be more agile is the way to go but, as discussed, don’t consider this to be a partnership. It’s a client-vendor relationship.

* As I know some of my audience are not in with the in crowd, LARP is Live Action Role Playing