In the aftermath of the global financial crisis (GFC), the banking sector has witnessed its best two years since 2007–2009.

With global revenues surpassing $7 trillion and net incomes of $1.1 trillion, the sector has demonstrated healthy profitability, robust capital and improved liquidity.

Despite this impressive rebound, scepticism lingers over the sector’s long-term value creation.

A price-to-book ratio of 0.9 – the lowest across industries – suggests a market expectation of eroded economic value, underscoring the persistent challenges banks face.

The Conundrum of Banking Valuation

Several factors weigh on the banking sector’s perceived value.

Rising interest rates buoyed recent performance, yet such improvements may be transient.

Without rate support, return on tangible equity (ROTE) in many regions would struggle to surpass the cost of capital.

Additionally, global variations in banking performance exacerbate valuation challenges.

Markets such as the United States, India and Germany saw ROTE improvements in 2023, while Brazil, Canada and China lagged.

Furthermore, banks grapple with productivity hurdles despite significant technological investments.

Labour productivity in major markets like the US has declined, even as annual global tech expenditures by banks exceed $600 billion.

The potential of generative AI remains largely untapped, constrained by regulatory requirements and implementation costs.

Simultaneously, operational cost reductions have reached diminishing returns, further complicating efforts to sustain margins.

Competition and Structural Pressures

Non-traditional competitors, such as neobanks and private capital firms, continue to erode traditional banking profit pools.

At the same time, macroeconomic uncertainties – ranging from quantitative tightening to declining consumer and corporate loan demand – create additional headwinds.

The commercial real estate sector exemplifies these challenges, with US originations down 55% from pandemic peaks and price indices declining across key markets.

Geopolitical uncertainties and evolving regulatory frameworks, including Basel III revisions, further compound the complexity.

These factors collectively explain the market’s cautious outlook on banking’s future.

Blueprint for Escape Velocity

Despite these challenges, opportunities for transformation exist.

Analysis of high-performing banks reveals a path to sustained value creation, combining structural choices with operational excellence.

1. Strategic Positioning: Outperforming banks often operate in attractive markets characterised by high margins and favourable demographics. For instance, markets like Canada and India offer significant credit demand and economic growth potential.
2. Revenue Diversification: Successful banks exhibit revenue growth 1.5 times their local GDP growth and generate at least 40% of their income from fee-based services, such as wealth management and advisory solutions.
3. Operational Efficiency: Efficiency ratios below 50% and disciplined risk management distinguish leaders from their peers, enabling them to navigate economic cycles with minimal disruption.
4. Innovation and Adaptability: Leading banks leverage technology and data analytics to enhance decision-making, improve customer experiences and unlock new revenue streams. Early adopters of AI have already realised billions in efficiencies, demonstrating the transformative potential of such technologies.

Looking Ahead

The path forward for the banking sector is both challenging and promising.

To restore investor confidence and achieve sustained growth, banks must embrace bold, transformative strategies.

By optimising operations, diversifying revenue streams and leveraging emerging technologies, banks can position themselves to thrive in an evolving financial landscape.

While the journey to escape velocity requires significant effort, the rewards – a revitalised sector capable of creating long-term value – are well worth the pursuit.

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