McKinsey & Co. has issued a big new report on the future of the banking industry. As has been observed by a wag, it basically constitutes a pitch for business by the strategy consulting firm, which is suggesting banks need to get their houses in order, urgently, before the next catastrophic downturn comes their way.
McKinsey's report mostly deals with the sorry state of retail banks but it does have a few things to say about the investment banks that operate in a universal banking structure. These things are encapsulated in the chart below.
Operating costs and industrialization potential in investment banks
Source: McKinsey & Co.
As per the chart, McKinsey says the front office of corporate and investment banks (CIB) accounts for 10% to 12% of costs in the average universal bank, while the operations associated with the corporate and investment bank account for another 8% to 10%. Universal banks' other IT and support functions are not CIB-specific, but housed in centralized departments that work across divisions.
McKinsey's main message is that banks need to very quickly get far more aggressive about cutting costs. "The impact from traditional cost-cutting is rapidly diminishing," says the consulting firm. "Even with years of cost-cutting following the financial crisis, most banks have not made the material improvements in productivity needed to compete effectively with fintechs, neo banks, and digital giants."
Most worryingly of all, McKinsey says nearly 60% of banks are not generating returns that cover their cost of equity and that after failing to take action earlier in the cycle they now need to take "bold" moves urgently.
Those bold moves inevitably involve hiring McKinsey (although the report doesn't explicitly say so). They also involve moving all, "non-differentiating activities to 3rd–party utilities."
Non-differentiating activities are those included in the dark columns on the righthand side in the diagram above. By moving to third party utilities, banks will be able to "industrialize the cost base," in low cost third parties, says McKinsey.
Which jobs in corporate and investment banks are at risk of this industrialization? McKinsey says plenty of technology jobs are suspectible. - It estimates that less than half the costs in "IT and support functions as well as some operations" are directed to towards activities that truly differentiate banks from competitors. The implication is that up to 50% of banks' technology jobs could be shunted into "multi-tenant' utilities used by various banks at the same time.
In fact, McKinsey & Co's idea is nothing new. UBS CEO Sergio Ermotti has been talking about outsourcing entire support functions for years, as have consultants at Oliver Wyman. After today's miserable results from UBS when profits in the investment bank fell nearly 60% year-on-year in the third quarter, the impetus for making the change soon looks a lot greater than before.
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