The past 18 months have been the best period for the global and African banking sector since at least 2007, with rising interest rates boosting profits, according to McKinsey & Company's 2023 Global Banking Annual Review released yesterday.
While the banking sector in South Africa generated around $5 billion (R95bn) in profits over the last year and while its return on equity (ROE) recovered, it remained range-bound at 14% in 2022 and 2023, as the sector’s balance sheet continued to generate value below cost of equity.
This as Africa’s banking sector generated $22.3bn in net profits in 2022, with an average growth of about 8% annually since 2021, the review noted.
Africa also outperformed the global trend with ROE of 15% recorded in 2022 and 16% in 2023, with some African banks amongst the most profitable.
Higher interest rates across most of the continent ended the years-long trend of margin compression, according to the review.
Globally, financial institutions were generating the highest profits in more than a decade, resulting in about $400 trillion in assets and generating $6.8trl in revenue in 2022. This upturn arises from the improvement in net interest margins that boosted the sector’s profits by about $280 billion in 2022 and lifted ROE to 12%in 2022 and an expected 13% in 2023, compared with an average of just 9% since 2010.
Banking is rapidly changing, which the report calls, the “Great Banking Transition".
The report said, "In a story that has been developing for several years, assets and clients have been flowing from traditional financial institutions that are capital heavy, such as universal banks, to non-traditional institutions that are capital-light. The latter include payments systems, financial data, and infrastructure businesses, standalone wealth and asset managers, private capital and equity business, and fintechs.
“While the growth of assets under management outside of banks’ balance sheets is not new, it merits attention now because, according to our analysis, the traditional core of the banking sector—the balance sheet—is at a tipping point: the flow has attained a scale that can fundamentally alter the nature of the financial services industry. "
Mohan Sambandan, a partner at McKinsey’s Johannesburg office, said this trend was challenging South African financial institutions to consider how they would set themselves up for similar success in this fundamentally new environment.
“Enablers of high performance, which include breakthrough disruptions, ecosystem plays, and cost- efficient service delivery models are performing well in the Great Transition. This is leading to increased competition with enablers pressuring banks to either invest or release capital,” said Sambandan.
He said South African institutions would have to adapt to the changing environment of the Great Transition, especially the trends of technology, regulation, risk, and scale, while mergers and acquisitions might also gain importance.
“The gap that we already see between industry winners and losers could increase even further as the transition gains momentum,” said Sambandan.
In an interview drilling further into the report, Sambandan, said on Wednesday, “The banking sector in South Africa is facing several challenges that are impacting its performance and driving up the cost of equity. One of the major factors contributing is macro-economic uncertainty, driven by weak forex, volatile investment flows, and high sovereign risk. This uncertainty and resultant higher COE (cost of equity) is not unique to South Africa, as is observed in most African countries.
In addition to macro-economic challenges, the operating model of the South African banking sector was more asset-led, resulting in balance sheet driven revenues and higher capital requirements.
South African bank’s share of balance sheet revenues were much higher (63%) compared to other banks globally (53%), and they are under-weight on capital-light banking services, such as “transaction” or “distribution”, he said.
“Despite these challenges, there is wide divergence in the performance of banks within the South African banking sector. The top performers are delivering a return on equity of more than 18%, compared to the market average of 14%. To overcome these challenges, banks will need to look to reinvent their business models and focus on boosting productivity with the use of technology and AI, scaling up transaction and distribution led businesses, and manage risks related to both macro and business operations,” Sambandan noted.
The report also identified that about half of the best-performing banks in the world could now be found in the Indo-Crescent region, which was expected to experience accelerated growth across retail and wholesale banking.
Countries along the crescent include advanced economies, such as Australia and Singapore, but also developing markets, including Kenya, Mozambique and Tanzania.
The area has become a testing ground for a deeper reinvention of banking, raking in 8% of global banking assets and 51% of the top-performing financial institutions globally.
“This superior performance is enabled by several factors, including higher GDP (gross domestic product) and population growth in some, but not all, of the Indo-Crescent countries,” it said.
BUSINESS REPORT