Asia-Pacific Banking Review 2019 - McKinsey & Company
Global Banking PracticeAsia-Pacific Banking Review 2019Bracing forconsolidation:The quest for scaleJuly 2019
Authors and acknowledgementsJacob DahlSenior PartnerHong KongVito GiudiciSenior PartnerHong KongJoydeep SenguptaSenior PartnerSingaporeSuho KimPartnerSeoulErvin NgAssociate PartnerSingaporeThe authors would like to acknowledge the contributions of the team—Aalind Gupta,Amanda Teo, Belinda Ong, Donna Soh, Fabien Chen, Gabriela Gunawan, GenevieveCham, John Crofoot, Khadijah Suhaimi, Teddy Nguyen, Yihong Wu, and the Panoramateam—as well as the countless number of partners, colleagues, industry and topicalexperts, and communications experts to this report.
Bracing for consolidation:The quest for scaleIn the previous Asia-Pacific Banking Review in 2016, we wrote thatthe Asia-Pacific banking industry was heading into a storm. Overthe past three years, the storm has worsened. There are rays of lightbreaking through the clouds, but only a small number of bankswill climb above the storm, unlocking the potential of scale to boostproductivity, optimize capital, and pursue strategic growth. Makeno mistake about it, consolidation is looming on the horizon. Theroad ahead is difficult, and less efficient banks will disappear.For many years Asia-Pacific’s banking industryhas outperformed global banking averages. Today,however, as the region’s emerging economiesmature, its banking industry is converging withglobal averages on margins, returns on equity, andprice-to-book multiples. In addition, as economicgrowth across the region slows (especially inemerging economies) and digital attackerschallenge incumbents both in customer acquisitionand share of wallet, banks are grappling withthinning margins, declining asset quality, and risingcapital costs. We believe that the forces sappingstrength from Asia-Pacific banks point to possibleconsolidation, as they exert pressure on banks toachieve scale benefits in distribution, productivity,and capabilities.As capital is drawn to organizations generatinghigher returns, weaker organizations may find itdifficult to raise the capital they require. Smallerinstitutions, including new disruptors and specialistscan also survive, provided that they offer superiorvalue to niche segments. In many cases, pursuing apartnership or merger may be the most efficient wayto build scale, boost productivity, and consolidatetechnology and talent.To prepare for the battles ahead, banks must firstattack costs and seek to achieve market-leadingefficiency ratios. Those that develop best-in-classdigital and analytics capabilities will also be in aposition to capture significant new revenue in fourfast-growing businesses: wealth management, retaillending, small and medium enterprise lending (SME),and transaction banking. As they seek to build scale,banks should also develop a systematic practice formanaging partnerships, joint ventures, mergers, andacquisitions.To emerge successfully from a period of potentialconsolidation, banks must reinvent themselvesor risk disappearing. For many organizations, thebuilding blocks for a data-driven, customer-centricdigital banking business are already in place. Inorder to carry through with the transformation,however, banks must shift to a more flexibletechnology architecture and operating model,build up their data and analytics capabilities, anddevelop a plan for acquiring and developing thenew talent required for the workforce of the future.High-performing banks will likely acquire smallerorganizations to achieve synergies of scale, marketshare, technology, and talent.Asia-Pacific Banking Review 2019 — Bracing for consolidation: The quest for scale1
The storm intensifiesIn our 2016 Asia-Pacific Banking Review, we warned that a stormwas brewing due to slowing macroeconomic growth, attackers,and weakening balance sheets. Three years on, these forcescontinue to exert pressure on the region’s banks, and forwardlooking indicators suggest that many banks will struggle as thestorm worsens. We believe that the combination of low growth,thinning margins, possible higher risk costs, and the need forscale efficiencies point to potential consolidation. As they bracefor this possibility, there are several efficiency measures andgrowth strategies that banks should pursue in order to maximizevalue. We discuss these opportunities, following our examinationin the present chapter of historical trends, the future outlook,and possible consolidation in Asia-Pacific banking.Historical trendsGrowth tapering in the world’s largest regionalbanking marketThere are two ways to look at Asia-Pacific banking.On the one hand, it appears to be strong andgrowing. In 2018, Asia-Pacific banking generatedrevenues of approximately 1.6 trillion. The region’sprofits (before taxes) topped 700 billion in 2018,representing 37 percent of global banking profitpools.1 Revenue and profit pools continue to grow,average returns on equity (ROEs) stand comfortablyabove the cost of capital, and total returns toshareholders for Asia-Pacific banking exceed TRSfor global banking by 51 percentage points.2On the other hand, closer scrutiny reveals a soberingsituation. Multiple trends show clearly that thedays of a free lunch and fast growth—especiallyfor banks in emerging markets—are behind us.Asia-Pacific banks are facing challenges typical ofmature markets—including slowing growth, thinningmargins, higher capital requirements—and in manycases will need to build scale to strengthen theircompetitive position.122Tapering growth is the most obvious sign of aweakening environment for Asia-Pacific banking.The region’s banks enjoyed double-digit annualgrowth from 2010 to 2014, but from 2014 to 2018,annual revenue growth slowed to five percent, andgrowth in profit pools slowed to three percent. Whilethere was a slight recovery in banking profit poolsin certain markets from 2017 to 2018, the longertrend of slowing GDP growth in China and India,Asia-Pacific’s two largest emerging economies,has weakened economic expansion for the entireregion and dampened demand for banking services.Over the same period, banks in Europe and NorthAmerica have rebounded from the 2008-09 crisis,meaning that Asia-Pacific’s share of global bankingprofit pools is shrinking (Exhibit 1 ).Non-performing loans are still risingExamining the situation more closely, we see severalsignals that weakening industry performance is notsimply a reflection of the slowing macroeconomiccycle but also results from significant changes inthe market. The average risk cost provision for theAsia-Pacific market was approximately 0.30 percentMcKinsey Panorama Global Banking PoolsBased on a sample of 2,000 listed banks across markets. 2017 data from SNL, Thomson Reuters, McKinsey Panorama Global Banking PoolsAsia-Pacific Banking Review 2019 — Bracing for consolidation: The quest for scale
Exhibit 1Asia-Pacific’s share of global banking pre-tax profit pools has declined due to slower growthand post-crisis recovery in other regions.Profit before tax1 billion, fixed 2018 FX rate, 0-14,%CAGR2014-18,%-131576123North America-2218718%Europe2-3215197%Latin America1013142%Middle %20142%20151%20162%20172018Total pre-tax profit pools of all customer-driven banking activities, including retail and institutional management.Includes Western and Eastern Europe.Source: McKinsey Global Banking Pools12in 2018. This is the highest level of loan losses forthe region since 2002, when the average risk costprovision for emerging and developed Asia-Pacificmarkets hit approximately 0.31 percent.For emerging markets, the average risk costprovision spiked from 0.43 percent in 2015 to 0.49percent in 2018. 3 Non-performing loan (NPL) ratiosin Thailand, Vietnam, and Indonesia are especiallyhigh, but pale in comparison with the crisis in India34(concentrated in wholesale lending by public sectorbanks), where NPLs accounted for 11.7 percent ofloans in 2018. 4The decline in returns on equity continuesOver the past decade, the story has been therebalancing from West to East, as growth in AsiaPacific has driven global economic growth andgenerated robust returns. Now, the combination ofslower growth with rising risk and capital costs inMcKinsey Panorama Global Banking PoolsWorld Bank databaseAsia-Pacific Banking Review 2019 — Bracing for consolidation: The quest for scale3
Exhibit 2Return on average equity of Asia-Pacific banking has been drifting down toward the globalaverage.Return on average equity, 2010-18, %2420 8.19.07.97.65.610.19.58.1APAC EmergingAsia-Pacific (APAC)GlobalAPAC rce: SNL; McKinsey Global Banking Poolsemerging economies is creating a new equilibrium,as seen in the convergence of Asia-Pacific bankingreturns with global averages. The average ROE forAsia-Pacific decreased from 12.4 percent in 2010to 10.1 percent in 2018. The average ROE for globalbanking was 9.5 percent in 2018 (Exhibit 2).If rising risk costs have eroded banking ROEssignificantly in emerging markets, thinning marginson fee and interest income have cut deeply intoreturns across developed and emerging marketsalike, as banks face increasingly fierce competitionfrom both peer banks and digital attackers. Risingcapital costs (due to a combination of stricter4regulatory requirements and inefficient capitalmanagement) are another significant drag onreturns (Exhibit 3). (See Appendix A for a summaryof the factors behind the decline in banking ROEsacross major Asia-Pacific markets.)Improvements in cost-efficiency help, but bankscan do betterWhile many banks have improved efficiencythrough infrastructure improvements and extensivedigitization, among other measures, these actionshave not been sufficient to reverse the generaldecline in ROE. In some markets, including theregion’s giants, China and Japan, the biggestAsia-Pacific Banking Review 2019 — Bracing for consolidation: The quest for scale
Exhibit 3In most markets, the impact of lower margins has been tempered by more cost efficiency;emerging markets have struggled with rising risk costs.ROAE for Asia-Pacific markets,1 2014-18, %CAGR 2014-18ROAE Margin2014, %Asia-Pacific Riskcost2Below -1%Between -1% and 0% Cost Taxesefficiency3Between 0% and 1% Fines and Capitalothers4 Above 1%ROAE2018,5 6%-2.6%0.7%1.2%0.6%-0.4%-1.3%12.9%Hong %-0.1%0.1%0.0%0.3%12.1%South tnam7.3%2.9%1.7%-0.7%-0.4%-0.4%1.9%12.2%Rest of arketsEmergingmarketsMainlandChinaBased on a sample of 700 banks and non-bank financial institutions in Asia.Loan loss provisions to average assets.Operating cost to average total assets.4Includes the residual after operating expenses and taxes.5ROAE figures might not add up due to rounding.6Includes Philippines, New Zealand, Pakistan, Kazakhstan, Sri Lanka, Myanmar, Cambodia, and Laos.Source: SNL; McKinsey Global Banking Pools123factor behind stronger cost-to-asset (C/A) ratioshas been the expansion of lending volumes. 5 Asvolume growth slows, however, it will becomeincreasingly important to leverage state-of-the-artcapabilities in areas such as digitization, robotics,and machine learning to boost productivity across5diverse functions, from account opening and knowyour-customer (KYC) reviews, to loan processing,customer service and other areas.Not only has volume growth driven the improvementin productivity measures in several markets, itis also the main source of growth in bank profitsS&P Global Market Intelligence (SNL) databaseAsia-Pacific Banking Review 2019 — Bracing for consolidation: The quest for scale5
throughout all Asia-Pacific markets. 6 Profits fromnet interest margins and fee margins are declining,making the growth in loan and deposit volumesthe last remaining stronghold for profit growth.This should give industry leaders pause. Nimbledigital platform providers (armed with data-centricbusiness models that entail relatively low capital andoperating expenditures) are positioning themselvesto challenge incumbent banks with increasingforce. And, depending on regulators’ posturestoward innovation, these attackers may extendtheir deposit-taking and lending activities, cuttingfurther into the market share of incumbent banks. InChina, for example, Yu’e Bao, Ant Financial’s digitalsavings vehicle, has grown from managing lessthan RMB 200 billion7 (approximately 30 billion attoday’s exchange rates) in 2013 to surpassing RMB1.1 trillion ( 160 billion) in assets under management(AuM) in 2018. 8,9 In South Korea, messaging serviceKakaoTalk launched Kakao Bank in 2017 and grewto approximately eight million users and KRW 12.1trillion (approximately 10.4 billion) within 18 months.For a closer examination of the threats posed bydigital attackers—and banks’ potential to withstandthese attacks—see the sidebar “Will digitalattackers gain market share at the expense ofincumbents?” on page 12.Future outlookAsia-Pacific has entered a new phase in whichgrowth will be much slower than in recent memory,and the potential for protracted slow growth in Chinacould weaken the region’s growth even further.10In addition to macroeconomic headwinds, banksalso face increased competition with the gradualadoption of open banking standards and will likelycontinue to struggle with declining returns. Investorshave already registered their pessimistic outlookfor the industry, and price-to-book (P/B) multiplesfor Asia-Pacific banking have declined from 1.1 in2011 to 0.7 in 2018,11 trailing the global average forthe fourth consecutive year (Exhibit 4). Nearly twothirds of Asia-Pacific banks have a P/B ratio less6789101112136than 1.0 and could become acquisition targets forstronger banks seeking to build scale.Slower growth in ChinaGiven the weakening macroeconomic environment,banks will need to plan their investments carefullyand reach a new level of efficiency in order to growfaster than the broader economy. Asia-Pacificeconomies continue to grow, and in many marketsthe growth of GDP will remain comparatively strong.However, growth is slowing across most AsiaPacific markets.12Asia-Pacific is a large and complex regionaleconomy, with some markets heavily focused onmanufacturing and others more dependent onservices. What many Asia-Pacific markets have incommon, however, is significant dependence ontrade with China. This trade accounts for sevenpercent of South Korea’s economic output, 14percent of GDP in Malaysia, and 35 percent inVietnam. As the market generating half of bankingrevenues in the Asia-Pacific and 78 percent ofgrowth in the region’s banking profit pools between2010 and 2018, the tapering of China’s real GDPgrowth, from 7.9 percent in 2012 to 6.7 percentin 2018 will contribute to weakening demand forbanking services across the region.Trade friction between the US and China couldpotentially weaken the pace of growth in AsiaPacific markets that are strongly linked to China’seconomy. However, a stronger emphasis ondomestic trade within China could mitigate thenegative impact of trade tariffs on China’s growth,and some markets in the region may benefit as UScompanies seek alternative trading partners.The rapid expansion of China’s real-estate sectoris another source of concern, as a collapse in realestate prices could threaten the stability of theChinese banking system and ripple across theregion.13 The Chinese government’s efforts toreduce the role of shadow banking are expectedto yield systemic benefits over the long term. In theshort term, however, effects may include restrictionMcKinsey Panorama Global Banking PoolsWind Database“Meet the earth’s largest money-market fund,” Wall Street Journal, September 13, 2017, 295000“Money market funds on Ant Financial’s Yu’e Bao grew by 80 times on average,” China Knowledge, March 27, 2019, 05/ant-financial-money-market-fundIMF Economic Outlook, April 2019S&P Global Market Intelligence (SNL) databaseWorld Bank Open Data“China’s leaders fret over debts lurking in shadow banking system,” Reuters, December 28, 2017, t/china-risk-shadowbanking/Asia-Pacific Banking Review 2019 — Bracing for consolidation: The quest for scale
Exhibit 4Banks’ price-to-book multiples have declined, reflecting investors’ negative expectations.Price-to-book multiples,1 alAsia-Pacific2018Based on a sample of 2,000 listed banks across markets.Note: Book value does not exclude goodwill as the data is available only for approximately 60 percent of covered banks.Source: SNL; McKinsey Global Banking Pools1of the growth of private companies, which contributesignificantly both to job creation and China’seconomic expansion.14The trend toward open bankingAiming to speed up innovation and modernizationthrough competition, regulators across Asia-Pacificare gradually opening up banking systems tobroader participation.15 India now allows non-bankpayments services providers to connect directlyto its new infrastructure, the United Payments1415161718Interface (UPI), and Australia has also mandatedthat its four largest banks adopt open bankingstandards for a broad range of transactions.16 HongKong and Singapore are both issuing virtual bankinglicenses in an effort to spur innovation and tocreate greater efficiencies and resiliency within thebanking system.17,18Whether regulatory efforts to encourage openbanking lead to more direct competition or voluntarycollaboration between banks and non-banks,“Why banks are wary of Beijing pleas to back private companies,” Financial Times, February 20, 2019, -8b2a211d90d5Open banking regulations vary in the degree to which they focus on data sharing (as in the UK); pricing, third-party access to bankingsystems, and authentication (as in the EU); or risk control and interoperability (as in Singapore). In general, however, various open bankingregimes are part of a global trend in bank regulation emphasizing security, innovation, and market competition. Please see “PSD2: Takingadvantage of the open banking disruption,” McKinsey.com, January 2018.“Australia to force ‘big four’ to open banking data by 2019,” ZDNet, May 10, 2018, ew-digital-bank-licencestharman?xtor CS3-18&utm source STiPhone&utm medium share&utm term 2019-06-28%2019%3A06%3A51Asia-Pacific Banking Review 2019 — Bracing for consolidation: The quest for scale7
mounting competition between traditional banksand digital innovators will almost surely cut evendeeper into bank margins in coming years. Newentrants will find avenues to introduce highly relevantservices, with an unprecedented level of easeand convenience and low pricing. Some of theseat
1 McKinsey Panorama Global Banking Pools 2 Based on a sample of 2,000 listed banks across markets. 2017 data from SNL, Thomson Reuters, McKinsey Panorama Global Banking Pools Tapering growth is the most obvious sign of a weakening environment for Asia-Pacifi
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