Banks need to focus 5 priorities in tough transition environment

Phillip Isakpa 

A global banking environment that has seen great transition for the balance sheet, transactions and payments, would require that banks focus on five priorities to enable them to capture the moment, a report by McKinsey and Company, the multinational management consultancy, has recommended.

According to the report, regardless of the macroeconomic developments, financial institutions will have to adapt to the changing environment of the Great Transition, especially the trends of technology, regulation, risk, and scale, adding that mergers and acquisitions may gain importance.

The report authors noted that as financial institutions consider how they want to change, five priorities are outlined which, though not an exhaustive list, can serve as thought starters.

Proposed in the recently released, “Global Banking Annual Review 2023: The Great Banking Transition” by McKinsey, banks are advised in the report to pay attention to exploiting technology and Artificial Intelligence; flex and unbundle the balance sheet; scale or exit transaction business; level up distribution; and adapt to changing risks.

The report authors outline what and how banks should do this in the following briefing notes: 

• Exploit technology and AI to improve productivity, talent management, and the delivery of products and services. This includes applying AI and advanced analytics to deploy process automation, platforms, and ecosystems. Other principles associated with success include operating more like a tech company to scale the delivery of products and services; cultivating a cloud-based, platform-oriented architecture; and improving capabilities to address technology risks. Distinctive technology development and deployment will increasingly become a critical differentiator for banks.
• Flex and even unbundle the balance sheet. Flexing implies active use of syndication, originate-to-distribute models, third-party balance sheets (for example, as part of banking-as-a-service applications), and a renewed focus on deposits. Unbundling, which can be done to varying degrees and in stages, pushes this concept further and can mean separating out customer-facing businesses from banking as a service and using technology to radically restructure costs.
• Scale or exit transaction business. Scale in a market or product is a key to success, but it can be multifaceted. Institutions can find a niche in which to go deep, or they can look to cover an entire market. Banks can aggressively pursue economies of scale in their transactions business, including through M&A (which has been a major differentiator between traditional banks and specialists) or by leveraging partners to help with exits.
• Level up distribution to sell to customers and advise them directly and indirectly, including through embedded finance and marketplaces and by offering digital and AI-based advisory. An integrated omnichannel approach could make the most of automation and human interaction, for example. Deciding on a strategy for third-party distribution—which could be via partnerships to create embedded finance opportunities or platform-based models—can create opportunities to serve customer needs including with products outside the institution’s existing business models.
• Adapt to changing risks. Financial institutions everywhere will need to stay on top of the ever-evolving risk environment. In the macroeconomic context, this includes inflation, an unclear growth outlook, and potential credit challenges in specific sectors such as commercial real estate exposure. Other risks are associated with changing regulatory requirements, cyber and fraud risk, and the integration of advanced analytics and AI into the banking system. To manage these risks, banks could consider elevating the risk function to make it a true differentiator. For example, in client discussions, product design, and communications they could highlight the bank’s resilience based on its track record of managing systemic risk and liquidity. They could also further strengthen the first line and embed risk in day-to-day activities, including investing in new risk activities driven by the growth of generative AI. Underlying changes in the real economy will likely continue in unexpected ways, requiring banks to remain ever more vigilant.

The report admonishes banks to note that these priorities have significant implications for financial institutions’ capital plans, including the more active raising and return of capital.

It advised that as financial institutions reexamine their businesses and identify their relative competitive advantages in each of the balance sheet, transactions, and distribution components, they will need to ensure that they are positioned to generate adequate returns, adding that they will also need to do so in a very different macroeconomic and geopolitical environment and at a time when AI and other technologies are potentially changing the environment and with a broader set of competitors. 

“Scale and specialisation will be determinant, as will value-creating diversification. Minimum economies of scale are also likely to shift, especially where technology and data are the drivers of scale. The years ahead will likely be more dynamic than the immediate past, with the gap between winners and losers increasing even more. Now is the time to begin charting the path forward,” the report authors further advised.