Commercial banking revenue has risen recently, but several trends threaten to put a damper on future growth, according to a report released Wednesday by McKinsey & Co.
The consulting firm's report "Accelerating Growth and Profits in North American Commercial Banking" provides a sweeping overview of challenges facing commercial banks that serve midsize companies.
Commercial banking revenue grew 4% in 2013 from the previous year, to $87 billion, according to the report. A rise in lending boosted profits as the industry largely recovered from the financial crisis.
But the sector faces several obstacles as it looks to sustain its recent growth in the coming years.
As commercial banks seek to expand, they face a declining share of the market for lending to companies with annual sales of $25 million to $500 million. Between 2012 and 2013, the market share controlled by banks fell by eight percentage points, to 73%, as business-development companies and hedge funds have expanded their commercial lending portfolios.
At the same time, profits from lending portfolios have been squeezed in recent years. Between 2010 and 2013, margins fell 30%, to 258 basis points, McKinsey said, citing data from Automated Financial Systems, a treasury management firm in Exton, Pa.
To boost profitability, many banks have relied on revenue from cross-selling products such as cash management services and corporate finance products. In particular, banks that earned more than half of their revenue in 2013 from non-lending products reported the higher measures of asset productivity a comparison of total revenue to loan volume.
"With returns under pressure, it's even more important to drive cross-selling," Nils Hoffman, a principal at McKinsey, said in a phone interview Tuesday, adding that cross-selling allows banks to "earn your cost of equity."
In addition to market pressures, a wave of new regulations will have a significant impact on the commercial banking industry's growth trajectory.
The implementation of Basel III regulations is expected decrease return on equity across the industry by between two and four percentage points, to 11% to 13%, according to the report. The global banking regulations, which will be phrased in for many banks in January, will require banks to meet heightened capital standards.
New liquidity and stable-funding ratios will also "push banks toward more stable, longer-term liabilities on one side of the balance sheet, and more liquid assets on the other," McKinsey said.
Meanwhile, the report suggests that commercial bankers have grown weary of investing in initiatives to boost customer experience such as high-tech services and relationship banking. More than three-quarters of banks reported working on such initiatives, but only half said that they had noticed results.
"Despite years of investment, banks have not yet found the way to move the needle on this issue," McKinsey said in the report.
The report also notes that commercial bankers have been slow to embrace digital technology, as middle-market lending executives continue to rely more heavily on face-to-face meetings than on web-based tools.
"Given how expensive it can be to build a digital offering, the return on investment is thought to be too small," the consulting firm said.