Banks could lose up to 60 per cent of their retail profits to nimble fintech firms within the next decade, according to global consultancy McKinsey & Co., offering a particularly alarming outlook as new financial technology players nibble away at some of the more vulnerable areas of traditional banking.
The consultancy said that altogether banks are producing profit of some $1-trillion (U.S.) globally, providing a powerful incentive for startups to grab even a thin slice of that business with cheaper or more convenient services. Given that the number of startups is now estimated at 12,000, these slices can add up to a major threat.
"The changes to come over the next 10 years will be less visible than the global financial crisis or the bursting of the dot-com bubble – and yet their impact on banking's economics and even fundamental business models will be much more substantial," McKinsey said in its 2015 annual review of global banking, released on Wednesday.
To quantify the threat, McKinsey looked at different business lines within traditional banks, and found that five retail lines were particularly vulnerable because many startups can improve the customer experience through appealing technology.
Consumer finance – the banks' core business of deposit taking and lending – is deemed the most at-risk: McKinsey estimates that 60 per cent of profit and 40 per cent of revenue could disappear by 2025, though the impact could vary by country. In dollar terms, $674-billion in global bank revenue would shrink to less than $400-billion.
In Canada, retail banking accounts for 50 per cent to 70 per cent of the profits of the Big Six banks, underlining why chief executives have been highlighting the urgency to adapt to changes.
The threat, McKinsey argues, isn't that new players will take balances away from the banks, but rather will take over the customer relationship and sales opportunities as disruption kicks in and migration toward non-bank services grows exponentially.
"The consequences for banks are quite dramatic," McKinsey said in its report. "The substantial value that banks generate from distribution may be captured by others. Margins will come under pressure, and the customer relationship, a platform from which banks sell other, higher-margin, fee-based products, will be weakened or might even disappear."
Similarly, bank profit from payments could slip by 35 per cent as companies such as Apple Inc. and Google Inc. capture market share with mobile-payment services that allow consumers to make small purchases with their smartphones. Profit from corporate lending, wealth management and mortgages will also fall by 20 per cent to 35 per cent, the report said.
The situation isn't hopeless, though. McKinsey suggests that banks can meet these threats and carve out a larger market share during this period of upheaval if they're ambitious.
The solution, they believe, is for the banks to move away from a culture based on selling products to one that embraces digital banking and innovation. Banks must also build a stronger connection with customers – particularly with younger millennials, the next wave of banking customers, who are more inclined to trust technology-driven brands.
Canadian banks have recognized the challenges ahead and have been working to build impressive internal technology divisions that foster innovation. They are also keen to partner with technology hubs, such as Communitech and MaRS Discovery District, or visit Silicon Valley.
Victor Dodig, chief executive officer at Canadian Imperial Bank of Commerce, delivered a speech in June that addressed many of the issues raised by the McKinsey review, with an emphasis on innovation and deepening relationships with customers.
"In fact, we are responding with nothing less than a top-to-bottom reinvention of ourselves, and the traditional banking model," Mr. Dodig said.
The stakes are high, according to McKinsey: "Those that do not seek to transform may well become somewhat digitized, but will likely be stuck in the middle – outwardly modern, inwardly struggling, and moving slowly toward extinction."