Banking has had a couple of very good years—the best, in fact, since the global financial crisis of 2007–09. Yet to some, the industry’s outlook seems less buoyant than recent profitability might suggest. On this episode of The McKinsey Podcast, McKinsey Senior Partners Klaus Dallerup and Pradip Patiath speak with McKinsey Global Editorial Director Lucia Rahilly about McKinsey’s latest global banking annual review, breaking down the sources of skepticism, the risks and opportunities of a changing landscape, and lessons leaders can take from banks that have consistently outperformed over the past decade.
But first …
Despite some challenges, M&A markets are thriving. Read more in our M&A Annual Report. Also, investing in affordable housing could lead to more than a million jobs, plus add nearly $2 trillion to GDP through 2035. Check out more details in our Investing in housing report.
The McKinsey Podcast is cohosted by Lucia Rahilly and Roberta Fusaro.
This interview has been edited for clarity and length.
First, the good news
Lucia Rahilly: I love that your latest annual review of the banking industry starts with what is possibly an Oscar Wilde witticism: “Everything’s going to be fine in the end. If it’s not fine, it’s not the end.” Right now, banking is not just fine; it appears, at least at a high level, to be downright rocking. It is the single-largest profit-generating sector in the world. Before we dig into the roots of skepticism on banking’s potential for long-term value creation, tell us very briefly what’s going right for banks these days.
Pradip Patiath: You hit the nail on the head. On the surface, banking is an extraordinarily important, critical, and successful industry. It’s important because it lubricates commerce. It’s been successful because banking by nearly any measure—$400-plus trillion in assets intermediated by banks globally, about $7 trillion in revenue globally (larger than nearly any industry), $1.1 trillion in net income globally—you look at all these numbers, and you say, “Boy, that’s a leviathan and seems to be doing well.” There’s a lot of good news.
Klaus Dallerup: Interest rates and net margins are just much better than they used to be. That helps banks perform better. They get something out of their balance sheet. And that dynamic is much healthier now than it was five years ago.
It’s also an industry that has figured out which assets are less risky and how to make sure that they’re what’s on our balance sheets. Banks are healthier than ever in many dimensions. That’s seen in their financial performance, and it’s something the industry can be proud of.
Why the skepticism?
Lucia Rahilly: Let’s turn now to some of the reasons the market expects banking’s economic value to erode. I was really surprised to see in the research that labor productivity growth has been mixed, particularly given that one might expect gen AI to have changed that calculus for the better. Talk to us about why productivity is a source of concern.
Pradip Patiath: This was one of the disturbing things we discovered. Relative to nearly every other major industry, banking is the one industry where labor productivity, indexed back a decade and a half, has declined versus increased. If you look at professional and technical services, productivity is up by 25 percent over the same period. If you look at nonfarm private businesses, it’s up nearly 15 percent. Banking is down 4 percent.
Two things have happened. Number one, banks have gotten bigger. As you go down the scale curve, you would expect productivity to get better. And number two, banks have spent and continue to spend a lot on technology. To be specific, banks globally spend $600 billion, give or take, on technology. That’s larger than the high-tech industry spends on technology.
Despite scale being thought of as a panacea and technology spend expected to deliver productivity, the data does not support that.
Lucia Rahilly: What’s our theory on what’s going awry?
Klaus Dallerup: Banks have been technology companies for a long time. They were among the first industries to embrace technology and use it properly. But that also means they have a lot of legacy technology. Technology is going very fast, and most banks were built 30, 40, 50, 70, 100 years ago. Their legacy is very deep, and that’s why spending is big. But the markets don’t value that legacy. They value what comes in the future.
Pradip Patiath: One added point: Banking for the most part has been a case of “and” and not “or.” In other words, when ATMs came along, or when mobile came along, it’s not like banks had to shut down branches. It’s not clear that in most markets you can save by shutting down other distribution channels. That means escalating “ands” and, barring a few markets, very few cases where that spend has been an “or”: I invest in this and therefore, I don’t have to do something else. For example, most checking accounts are still open in branches in the United States. Closing branches is not a viable strategy at this time.
Lucia Rahilly: I understand what you’re saying about catering to heterogeneous preferences now. Do you see analog interactions—checking accounts, going into the branch—phasing out, say, in five years? Will they occupy a smaller and smaller portion of banks’ business?
Klaus Dallerup: Predicting the death of the branch is probably not what we want to do. One thing that’s very certain is that human touch and feel is still very important. However, it doesn’t need to come via the same approach branches have used for many years. It very much depends on the markets, the bank, the technology.
Predicting the death of the branch is probably not what we want to do. One thing that’s very certain is that human touch and feel is still very important.
Klaus Dallerup
Lucia Rahilly: We used to joke about the headline, “The retail branch is dead. Long live the retail branch.”
Pradip Patiath: Banking has been around since the Sumerians—nearly the very beginning of human civilization. In fact, banks have continued to be a conduit that has helped civilization grow. Anyone who claims that banks or banking is dead has their head in the sand. That’s clearly not the case, also given we have 9,600 or so banks in the US, when you count credit unions and community banks and so on. It’s a slightly different competitive dynamic driven by industry structure than a market like Australia or Canada, where you have a more limited, single-digit number of banks. In the US, the adoption of cash to digital has been slower than in some other markets because it’s a vaster country.
There’s a bit of the prisoner’s dilemma, where you can’t be the last guy without a branch or the first guy without a branch when others have them. The market tends to move in unison, which perhaps lengthens the decay curve of shifting to pure digital distribution compared to newer markets, which could quickly leapfrog and not have to build those branches. There’s a lot of subtlety in how banks have had to be nimble, in terms of adopting while being cognizant of the competitive dynamic.
New attackers, new challenges
Lucia Rahilly: What about nontraditional competitors—say, fintechs or big tech—and their incursion into more traditional banking territory? What’s the state of play there?
Klaus Dallerup: That depends on big tech versus fintech. Banks have a very nice defensive mechanism: regulation. If you’re big tech, you think, “Am I equipped to go into a highly regulated space like this?” Some are willing; some, less so.
Fintechs are starting to think about how to redefine the path of banking, and in redefining that path, how to create a better experience than universal banks deliver in the branch, in the call center, even in online banking. And some have shown that they can.
It’s also very clear that the markets value models they fundamentally believe will scale and be more profitable and thereby have a more unified model. And we’ve seen lots of fintechs that have scaled across the globe, operating either in some of the big markets or across markets—not with a full offering, but with a slimmer offering attractive to a smaller group. That’s another great learning opportunity. Fintechs are pushing the industry to become more modern, more effective, and more customer-friendly.
Pradip Patiath: Banks are the ultimate fintechs, except with a capital F, small t. The actors you might worry about are “small f, capital T”: tech giants that have massive customer bases, huge investments, and an understanding of technology. If they start leveraging their customer position, their data, and their distribution to get into “small f” finance—avoiding the heavily regulated, painful stuff—they could start taking off the attractive finance pieces of banking. That is something to contend with, versus the “attack of the fintechs” that think they can take on the banking industry. That’s largely proved to be a fool’s errand. There are breakouts, but those are truly few and far between.
Lucia Rahilly: What about attackers from within financial services—wealth management or private credit, for example?
Pradip Patiath: Besides productivity and the fact that banking is somewhat hard to disrupt, the most attractive parts of banking—wealth management, payments, exchanges, information-related businesses like ratings—are the ones where banks have had to cede ground to wealth managers, insurance companies, and private equity players. These are the businesses that have very high multiples. Banks have had to cede ground partly because of regulatory constraints, partly because others have been more agile and nimble, partly because banks have been slower to respond. It’s all of the above.
Outrunning the competition
Lucia Rahilly: Let’s turn now from these challenges to what banking leaders can do to achieve, as you call it in the report, escape velocity, and run counter to skepticism. How should leaders be grappling with the question of where to compete?
Klaus Dallerup: They can look for scale advantages. They can look to expose themselves to some of the ingrained, more profitable markets. Even within one of those markets, they can double-click to the customer and segment level and see that some segments are more profitable than others. Investment-heavy segments like private banking and affluent banking are more interesting than everyday banking, where customers just have a basic payment account—at least if you’re a universal bank.
The paradox, of course, is that if I build infrastructures—such as a payment infrastructure—then I can create massive scale across markets. I get highly valued for that because it’s a technology and a platform that I can scale, and I don’t have to build it in every market.
Pradip Patiath: First, don’t ignore locations with rising tides. If you miss those, you end up missing a big boat. Second, don’t ignore demographic shifts. Banks should be well positioned, in terms of specific businesses, as people age and wealth transfer takes place over the next decade or two. Otherwise, they risk ceding ground to asset managers, wealth managers, insurance companies, and so on.
Third is deciding which businesses to be in—the business mix question. Being very deliberate about where you’re competing and what percentage of your business is allocated to different areas is important. Being more purposeful has been a key factor in determining the 14 percent of banks in our data that truly outperformed on returns and growth.
Lucia Rahilly: How are these outperformers gaining and maintaining an edge through execution?
Pradip Patiath: We call it management quotient, or MQ, in aggregate. It’s made up of several ingredients. Number one is the strategic component—where to compete. Which businesses am I going to be winning in? Which locations am I going to be doubling down in? Number two is the sheer metabolic rate of execution. Most banks talk about moving to an agile model, but the data shows they’re probably 20 percent agile, 80 percent nonagile. Agile is a way of working—it’s in pricing, distribution, finance, HR, and marketing. Less than one in five banks can claim to have fully moved to agile defined that way.
Number three is the businesses that have high fees, high profiles, and are largely fee-based businesses. It’s not easy to get into those because you have gorillas in those businesses. So, what’s the angle for banks to gain ground in wealth and payments? For example, in an industry structure like the US, where you’ve got very large, entrenched players, many banks have struggled to win in wealth management because it’s a difficult, nonobvious play. The old playbook—just repeating it—may not yield.
And then I would add a fourth: technology, because it’s such a big part of where banking is going to be. You’ve got to really be thoughtful about how and where to spend to get the most bang for the buck, particularly as it relates to tech.
Lucia Rahilly: Do you see tech talent as a factor? We hear a lot about scarcity in talent markets generally, and that’s exacerbated by the fast-changing tech landscape and skill shortages in up-to-the-minute technologies.
Klaus Dallerup: Banks have always been tech companies, so they’ve always had to fight for the best talent. But here’s the complicating fact: Banking moves slowly. It doesn’t completely revolutionize itself in 12 or 24 months. And that means banks need people who can think strategically, execute, and lean into new technologies. But the process moves slowly—that’s the battlefield. Banks have a real task in showing people why this work is exciting and important. But people don’t see the difference in a quarter, or in the next quarter, or in the next quarter. Over a few years, they see a real difference.
Pradip Patiath: It’s like that famous joke about two chaps out camping. A bear appears, and one starts running. The other bends down to put on his running shoes. The first chap yells, “Are you mad? Why aren’t you running?” The second chap replies, “I don’t have to outrun the bear—I just have to outrun you.” That’s the story of banking.
Historically, banking has attracted top talent compared with many other industries. It’s been an attractive—even “sexy”—industry to be in. But recently, the competition has changed. Now, banks aren’t just competing against each other. They’re competing with wealth managers, tech companies, and “sexy” payments players. So, it’s like stepping down to lace up your sneakers—you don’t need to outrun the bear. You just need to outrun the competition.
Finding opportunities in a volatile world
Lucia Rahilly: Let’s pull back from industry dynamics and look at rising volatility in the global macroeconomic landscape. Geopolitical tensions are burgeoning. Uncertainty is rising. In the throes of all this change, how should banks be preparing for potential shocks to the global financial system?
Pradip Patiath: This is the question du jour. Banks that ignore the macro environment—the geopolitical environment, the risks that come with it, the opportunities that come with it—do so at their own peril. This means local banks, global banks—it doesn’t matter. Look at some of the variables at play. Are we retreating from being more global to more multilocal or even national? Does that create opportunities for certain kinds of banks? The mix of shifts based on macro factors has to be considered.
Banks that ignore the macro environment—the geopolitical environment, the risks that come with it, the opportunities that come with it—do so at their own peril.
Pradip Patiath
Second, there are certain sectors—crypto, cannabis—that banks have largely been out of. If these were to become more open to banking, what opportunities would that create for banks?
Third, some nations have talked about CBDCs—central bank digital currencies. That could both be great and also pose a huge threat to banks in terms of the core business of banking. You could basically disintermediate banking, even though banking is supposed to be the intermediary between lenders and those who need capital.
Fourth is the risks that come with big tech—AI, quantum computing—that could massively exacerbate cybersecurity risks, cryptography, and so on.
Klaus Dallerup: New banks can be built from scratch, with half the ingrained cost of incumbent banks. That means there’s a trade-off: Do I build a new bank or maintain the old one? This is a great example to reflect on, especially in the world we live in now, with both technology and geopolitics shifting. The real question is, “How fast can banks adapt?”
What lies ahead
Lucia Rahilly: Pradip, you mentioned cryptocurrency. Anything more to say on how crypto might disrupt dynamics in future financial markets?
Pradip Patiath: I think, largely, banks, tech companies, and observers would agree that blockchain as a fundamental technology and capability is a yes. Regarding the coins and the exchanges on which those coins are traded, I’ve always believed the exchanges will be a good business because you’re effectively market making.
Let’s assume we’re talking about a good, normal exchange that’s basically operating to create a market between buyers and sellers and doing it legitimately and legally. If that’s the case, then I think that’s a good business. We need exchanges to help facilitate price discovery and enable transparency—as well as for custodial functions so you don’t have people who don’t have their money when they want to sell the assets, and so on.
The part of the crypto business that people have concerns about, and that merits legitimate debate, is when consumers naively speculate about the various crypto assets [coins] on the exchange without understanding the material risks. The unease many bankers and policymakers have with crypto coins and other crypto assets is that there isn’t a cash flow stream that you can nail down and value, unlike real assets, where the valuation mechanisms are better understood.
My view is we should experiment with crypto, but with caution. It looks like the US is surely headed that way. Let’s also be clear about what we’re talking about when we discuss “cryptocurrency.” Is it the technology, the market-making exchange function, the crypto assets, or other “apps” on the exchange.
Lucia Rahilly: Klaus, looking out over the next, say, five or ten years, what will be most valued?
Klaus Dallerup: For customers, personalization will become increasingly important. In the old days of banking, the branch person knew who your kids were, knew what you needed before you needed it. They’d call you and say, “Listen, you’re not saving enough to retire at the age you want.” Or, “You’re not insured well enough given the wealth you have.” That kind of personalization will only become more important, and the expectations are that banks will help more and more rather than just reminding you, “Your overdraft is due,” or “Your loan is running out.”
Corporates will increasingly expect banks to take care of them. They will expect banks to have a perspective on how best to manage risks, eg, advising against trading with companies that could go bankrupt, or on what type of enterprise resource planning system to buy so as not to spend as much time and money on bookkeeping. This will take some banks outside core banking.
Investors will value models that scale easily. That means you grow on your top line but keep your cost stable—that could be cross-border, in the country, or in multiple markets. And if that scalable model doesn’t require you to get more capital, that’s an added benefit. But luckily, these two things can coexist.
