From 2000 to 2007, top-performing banks had an average return on equity of 26%. Today, many of these same banks are looking at 5% — if they are still in business.
Without question, the postcrisis challenges facing U.S. banks are daunting. Having analyzed the growth outlook and objectives of more than 150 financial institutions, we believe that banks that make bold decisions on their business and operating models today will rebuild returns on equity to the mid-teens within a few years.
Banks will need to operate within safe parameters on key financial indicators such as leverage, loan-to-deposit ratios and Tier 1 capital ratios, adding to the difficulty of restoring profitability. The performance of many banks today indicates that they are not within these parameters — with an imbalance among deposits and loans, high leverage and large cost bases. They must pay more attention to building their assets through stable customer deposits and boosting liquidity reserves to become more "stress resistant."
We have identified four types of business models that can be expected to deliver healthy profits over the next three years.
Full service: Surprisingly, the full-service bank, offering some or all of the services associated with universal banks, will be one of the most common banking models to emerge in some markets.
Simplified service: These banks will focus on specific business or customer segments such as retail savings or wholesale banking. While the business model itself may significantly vary among these institutions, they will emphasize balance-sheet strength and highly efficient operations.
High-value-focused: A third type of business model will be built primarily around high-value customer relationships, rather than volume. Although typically operating with a higher cost base, these banks will strive to generate income through premiums on superior products.
Product specialists: Product specialists will choose to serve the financial needs of a wide range of customers. Typically, they will concentrate on core market segments, such as asset management or other high-value products where they can profitably compete. They may also need to divest business units where they lack scale.
These four models can also be used to evaluate the performance and future viability of individual divisions within banks. Having a clear picture of future scenarios is particularly important given the strategic decisions confronting many banks, such as whether to divest particular lines of business.
Once the most effective business model is determined, banks must align their operating model to it to achieve high performance. For example, simplified-service banks will require common processes across the organization to maximize efficiency in distribution and production. High-value-focused banks will organize around the customer, emphasizing superior service, product knowledge and product manufacturing to deliver differentiated service.
Banks with affirmative answers to the following questions on their growth, marketing, channel distribution and back-office strategies will be among the first to forge a path back to profitability.
- Can we take advantage of weakened competition to expand through M&A? What new fee-based products can we offer? Are there underserved customer segments within our reach (e.g., the Hispanic market)?
- Can we create a single view of the customer? Do our brands and services align by customer segment? Can we bundle products to increase wallet share? Are we identifying customer behaviors to improve product appeal? Can we partner with nonbanks to build customer loyalty?
- Do our customers have consistent product experiences across channels? Can we make better use of the Web to cast a wider net for new customers?
- Can we reorganize to offer third-party products? Can our operations become more efficient with fewer silos? Can our systems be consolidated to accelerate product launches?
While most banks are still mitigating losses, those that move quickly to articulate and implement a business strategy and operating model for the current realities can earns profits that will be rewarded by investors.
