As we approach the end of the second year of a worldwide pandemic, the global economy has surprised to the upside, and banks have escaped the worst. But the outlook for the industry remains clouded with half of banks not covering their cost of equity.
Unlike the previous economic crisis, this time banks did not witness any abnormal losses, material capital calls, or “white knight” acquisitions. In fact, bank profitability held up better than most analysts expected. ROE in 2020 was 6.7 percent—less than the cost of equity but still a better showing than expected and above the 4.9 percent observed in 2008 in the aftermath of the financial crisis. (A PDF of the full 2021 McKinsey Global Banking Annual Review, with more detailed data, and a set of strategic questions for banks, is available for download on this page.)
But if the pandemic has not had the expected harmful financial effects on the global banking industry, it has certainly had plenty of others. Digital banking accelerated, cash use fell, savings expanded, remote became a way of working, and environment and sustainability are now top of mind for customers and regulators.
The banking system is at least as solid as it was before the pandemic—and much healthier than after the last crisis. But can we say a bright and smooth future lies ahead for banks and their shareholders? Not really. Cause for concern is evident in banks’ performance on two yardsticks: ROE, a measure of current profitability, and market-to-book value, a leading indicator of how capital markets value banking.
Fifty-one percent of banks operate with an ROE below cost of equity (COE), and 17 percent are below COE by more than four percentage points. In an industry that has high capital requirements and is operating amid low interest rates, creating value for shareholders is structurally challenging. In fact, the almost $2.8 trillion of capital that was injected by shareholders and governments into banking over the past 13 years eroded three to four percentage points of ROE.
The challenges facing a capital-intensive industry in a low-price environment also show up in valuations. Banks are trading at about 1.0 times book value, versus 3.0 times for all other industries and 1.3 times for financial institutions excluding banks, with 47 percent of banks trading for less than the equity on their books. And these undervaluations persist even after a period in which the financial system as a whole gained about $1.9 trillion (more than 20 percent) in market cap from February 2020 to October 2021.
Out of 599 financial institutions we analyzed, just 65 accrued all the gains (Exhibit 1). Most of these deploy a specialized and capital-light business model or operate in fast-growing markets. A few universal banks also gained, but the vast majority either realized small gains in their share price or lost value.
