Profitability: Innovation for revenue and growth

Invest in innovation to future-proof your bank and expand market share.


The banking industry faces several challenges due to recent economic, geopolitical and regulatory developments. KPMG has identified the top 10 issues facing banks in 2022 and beyond, and in this article we examine the topic of profitability.


Revenue and Growth: The engine is tuned up

Banks fared extraordinarily well through the pandemic years of 2020 and 2021.  Early fears of credit performance deteriorating proved to be incorrect, digital engagement and behaviors received a pandemic boost as consumers accelerated their transition away from cash and branches, and many banks earned a “trust dividend” as they offered forbearance terms and participated in the distribution of government stimulus and relief payments and loans.

Heading into 2022, there’s cause for continued optimism: loan growth has emerged in recent quarters, forecast rate hikes should lift net interest margin (NIM) from recent lows, and credit quality remains strong.  Against this backdrop, KPMG’s 2021 CEO Survey revealed that, over the next three years, a majority of CEOs at U.S. banks expect earnings growth of as much as 2.5 percent per year, and a third said they expected even better earnings growth – as much as 5 percent. Almost 90 percent said they have a positive outlook on the overall national economy.

But near-term optimism, while welcome, comes alongside significant questions and challenges. Growth in total banking sector revenue, after consistently outpacing GDP growth during the decades-long economic period that began after WWII, dramatically slowed during the Great Recession of 2009–2010—and has not recovered. Revenue growth since 2010 has hovered around or slightly below 2 percent; CEOs’ expectations for 2.5 percent growth going forward are an improvement, but remain a far cry from the 7-plus percent rates of the ‘90s and ‘00s, let alone the prior decades of double-digit growth.  And while higher interest rates should have a positive impact on NIM, the accelerating economy will bring new challenges – higher rates are likely to reduce the stickiness of core deposits, and inflationary pressure on wages will challenge recent efficiency improvements.





Growth expectations over the next three years


 

55%


 

of CEOs are expecting their company earnings to grow by as much as 2.5% anually


 

35%


 

are expecting earnings growth as much as 5%

A core challenge for banks is that the banking market is not monolithic.  Different markets, at the state, county, and MSA level, offer very different prospects for growth and profitability.  Similarly, different products and services are at very different stages of maturity: For example, traditional “plain vanilla” spread-financing products may offer modest prospects for growth, while innovative new payments and treasury-management services, Banking as a Service value propositions, and emerging financing products (venture finance, clean energy finance, etc.) may enjoy high margins and/or very rapid growth.

So, are recent growth challenges cyclical, driven by persistent (but ultimately unsustainable) low interest rates and regulatory pressure on fees?  Is the industry on the precipice of a new boom in growth and returns, driven by digital and fintech innovation, increased demand for corporate and infrastructure financing, and the emergence of new product and service sets in payments and treasury management?  Or are recent challenges more secular in nature – the mark of a maturing industry with fragmented competitors and commoditized products, and an imperative to reduce cost, simplify, reduce risk profile. and emphasize capital return to shareholders?

There won’t be a single answer for the industry (or even for a single bank).  Winning institutions will craft strategies based on a foundational understanding of their capabilities and infrastructure, the markets they participate in, and the customer segments they serve.  Successful execution will require managing complex business portfolios with a balance of innovation growth “bets” and more stable, utility-like activities.


Taking Action in 2022 - Profitability

Click on each section below for actionable steps you can take now

Innovate

Banks looking to grow market share and generate above-average revenue and earnings growth will not succeed by offering the same products and services to the same customers, through the same channels, supported by the same infrastructure.   The “innovation bar” – the level of new thinking, value propositions, and delivery mechanisms required to access market growth – has continued to rise, and for all but the largest institutions now outstrips internal capacities for technology and alternative business model development.

The consequence: An imperative to partner with and invest in complex fintech ecosystems as a means of “insourcing” innovation and expanding potential market reach.  Connecting with fintechs at scale is itself a significant operational challenge and requires rethinking (and re-investing in) traditional business development functions.  Potential initiatives include:

  • The creation of in-house fintech accelerators and investment funds
  • The creation of innovation hubs and design centers for rapid prototyping of new product and service offers
  • Significant investment in more robust and more real time  third-party risk management and due diligence capabilities
  • Investment in an application programming interface infrastructure to enable more rapid, open architecture partnership models.

Maximize efficiency

Operating at lower cost is a clear means of improving earnings and outperforming competitors.  Investors understand this and value efficiency – but are also leery of cost-cutting efforts that risk being “yo-yo diets” with unsustainable impacts.  The implication for banks is to focus on creating business models with fundamentally and intrinsically higher levels of efficiency rather than simply cost cutting to higher earnings.  Our thoughts on approaches to maximizing efficiency are discussed further below.

Optimize business portfolios and strategies

It’s all about taking a dispassionate look at whether a bank’s current business lines actually collectively can grow the business, put limited resources to the best use, improve margins, and avoid wasting time and money. The issue is predicated on the idea that it is likely that many banks are spending too much time on lines that don’t match their strengths.

Whether it is inertia, resistance to change, fear of failure, or any of the myriad reasons banks cite as reasons for their slow pace of change today … the reality is this: Many banks are behind the curve on the transition to a leaner, strategically focused business.

Bank management will need to understand – in detail – which lines are optimal to their business and operating models.  They need to test their assumptions used to form the foundation of their decisions.

We believe that most bank business portfolios should contain a mix of higher-risk innovation “bets” designed to drive long-term growth and more stable and predictable established businesses.  Portfolios must be actively constructed and managed to maximize the probability of meeting earnings and profitability targets over time, while accounting for the volatility, capital consumption, risk, and earnings generation characteristics of individual activities.

We find that all too often, businesses that want to take a hard look at shifting strategic focus are searching for a fail-safe formula. In our view, such formulas do not exist. Like everything else, success is in the details.

Future-proof

Banks subject to Dodd-Frank Act and Comprehensive Capital Analysis Review stress testing requirements have spent a tremendous amount of time and money over the past decade building granular and robust scenario analysis capabilities.  These capabilities, built for regulatory response purposes, must now become an integral part of the business planning and business portfolio management process.  As 2022 gets underway, we face uncertainty on multiple dimensions: public health, international trade and geo-political environment, domestic political environment, macroeconomic growth and inflation, and so on.  Whatever profitability levers a bank plans to pull in 2022, it should do so armed with an understanding of how management actions will impact profitability and growth both in a “base case” future and in alternative futures that might arise from unexpected but still-possible and plausible developments.

Shifting to a higher gear
Download the full report to learn about all of the key issues impacting banks in 2022 and beyond


Connect with KPMG

Jack Whitt

Jack Whitt

Principal, Advisory Strategy, KPMG US

+1 703-286-8807
Dylan Roberts

Dylan Roberts

Principal, Advisory, Strategy - PDT, KPMG US

+1 212-997-0500