The McKinsey Podcast

Episode: The Changing Landscape for Banks

Date: January 11, 2024
Host: Roberta Fusara (McKinsey & Company)
Guests: Alex Edlich (Senior Partner), Reinhard Hull (Private Capital Partner)

Episode Overview

This episode unpacks the major structural, technological, and strategic shifts transforming the global banking sector, based on insights from McKinsey’s annual banking report, “The Great Banking Transition.” Roberta Fusara hosts senior partner Alex Edlich and private capital partner Reinhard Hull for a conversation on topics including the shrinking role of bank balance sheets, evolving risks, the impact of emerging technologies (especially generative AI), shifting distribution models, and practical guidance for leaders navigating this transition.

Key Discussion Points and Insights

1. The Evolving Role of Bank Balance Sheets

• [00:03–00:51]
  • Over half of the $402 trillion global financial assets are now off bank balance sheets—moved to mutual funds, insurance, pensions, and sovereign wealth funds.
    • Alex Edlich: “...over the last decade, 75% of the net increases have gone not onto bank balance sheets, but onto mutual funds, insurance balance sheets, pension funds, sovereign wealth funds.” [00:22]
  • Shrinking balance sheets have not prevented rising profits, as higher interest rates raised net interest margins by $280 billion in 2022.

2. Technological Shifts and GenAI

• [01:14–01:26]
  • Advances in technology are fundamentally changing banking—from legacy migrations to fast adoption of generative AI.
    • Reinhard Hull: “...now we're talking about genai and stuff you can actually in pretty quickly.” [01:14]

3. Disruption in Distribution and Customer Engagement

• [02:00–04:10]
  • Payments: Digital and contactless payments are growing, and embedded finance is reshaping checkout and transactional experiences.
    • Alex Edlich: “The shift to contactless digital payments is accelerating...demand for embedded finance…is also growing.” [02:00]
  • Banks face competition from payment specialists and investment banks, plus a consumer base increasingly using digital and mobile channels.
  • Up to 30% of retail banking distribution could shift to third-party platforms or partners (comparison sites, embedded finance).
    • Reinhard Hull: "We will see up to 30% of distribution in retail banking going via third parties...This can happen with the banks or against the banks..." [03:21]

4. New and Evolving Risks

• [04:10–05:57]
  • Banks must deal with volatile macroeconomics, new regulatory demands, and a broader spectrum of risks, including technology and cyber.
    • Alex Edlich: “Banks need to up their game to meet these changing risks.” [04:15]
    • Traditional risks (credit, market, liquidity) remain, but are compounded by technology risk, cyber-fraud, and risk from third-party partnerships.
    • Reinhard Hull: “...sometimes the risk may not actually come out of your organization, but actually coming from partners.” [04:42]

5. Mitigating Risk: Culture and Technology

• [05:57–07:36]
  • Solutions include instant payments technology (real-time KYC and fraud screening), cross-functional risk thinking (not silos), and a strong risk culture.
    • Reinhard Hull: “...risk culture is one of the strongest determinants...making sure that institutions...steer through all the difficulties.” [06:02]
    • On risk culture: “It's really a combination of the underlying mindset and the risk practices.” [07:11]
    • Responsiveness to emerging risks is now crucial.

6. Regional Differences and Global Trends

• [07:36–08:47]
  • De-risking/shifting assets off balance sheet is a worldwide phenomenon, but with geographic variation:
    • North America: 79% of new assets off balance sheet
    • Europe: 77%
    • China: 34%
    • Indo Crescent (East Africa, Middle East, India, ASEAN, Australia) leading in banking market performance.
    • Alex Edlich: “This is a global phenomena, for sure… in every geography except for Latin America and China, the share that's going off banking balance sheet is more than 50%.” [07:42]
    • Reinhard Hull: “The Indo Crescent...had the majority of the best performing banks...28% of market cap is in this region.” [08:32]

7. Technology and AI Strategy for Banks

• [08:47–11:48]
  • Top-performing banks are investing 2.5 times more in technology than laggards, using AI and analytics to improve productivity and client experiences.
    • Reinhard Hull: “...technology is not about simply your core banking system, but in particular generative AI...allows better and simpler customer interactions.” [10:07]
  • Banks must clarify where tech investment is a differentiator and align investment with regulatory, organizational, and client needs.
    • Example: Generative AI deployments can quickly boost coder productivity, but only if the workforce is brought along on the change.

8. Scaling, Exiting, and Partnering in the New Era

• [13:07–15:13]
  • Banks need to rationalize business lines: choose to scale, partner, or exit based on comparative advantage and market context.
    • Reinhard Hull: “...if you're a medium sized institution in the US...capital markets...is a scale driven business...someone else could do better for you.” [13:29]
  • After years of decline in banking sector M&A, a new uptick in activity—especially partnerships with or investment in fintech—may be on the horizon.

9. Rethinking the Balance Sheet—New Opportunities

• [15:13–18:22]
  • Banks should consider “unbundling” their balance sheet—syndicating or offloading assets for which other institutions are better suited.
    • Alex Edlich: “From a balance sheet standpoint, we do think that there is the ability to flex and sometimes even unbundle their balance sheet...” [15:26]
    • Reinhard Hull: “...for banks, this is really three opportunities:...do business which you ordinarily couldn’t do...risk diversification...onboard someone else’s credit exposure and generate returns.” [16:01]
  • But shifting risk doesn’t abdicate responsibility, and demands robust internal risk frameworks and collaborative, digital partnerships.

10. What Should Financial Executives Prioritize?

• [20:23–22:10]
  • Recognize that the next era (5–15 years) will be different—new interest-rate regime, new risks, new technologies, new forms of competition.
    • Reinhard Hull: “First and foremost, everyone should recognize that we're entering a new era...your strategy, your operation, your culture...needs to acknowledge that...” [20:30]
    • Alex Edlich: “Institutions are not doomed by their own business model...How you react...for some this is about being defensive, for some it's about going on the offense...” [20:57]
  • Despite challenges, banking has reached historic highs in profitability post-2022.

Memorable Quotes with Timestamps

• “There are $402 trillion in assets that exist in the the global financial system. More than half of that is now not on bank balance sheets.”
  – Alex Edlich [00:22]

• “We will see up to 30% of distribution in retail banking going via third parties...This can happen with the banks or against the banks...”
  – Reinhard Hull [03:21]

• “Banks need to up their game to the next level to meet these changing risks.”
  – Alex Edlich [04:15]

• “Risk culture is one of the strongest determinants and a positive sense of making sure that institutions...steer through all the difficulties.”
  – Reinhard Hull [06:02]

• “The best performing banks, so the top 10, invest on average two and a half times more into technology than the bottom 10.”
  – Reinhard Hull [10:07]

• “Institutions are not doomed by their own business model...for some this is about being defensive, for some, it's about going on the offense.”
  – Alex Edlich [20:57]

Timestamps for Important Segments

• 00:22 — The global shift of assets off bank balance sheets
• 02:00 — Tech, contactless, and embedded finance disrupting consumer payments
• 03:21 — Retail distribution shifting to third parties
• 04:15 — The new spectrum of risks and regulatory challenges
• 07:42 — Variation in balance sheet changes by region
• 10:07 — Generative AI and banks’ changing tech investment strategies
• 13:29 — Scale vs. exit vs. partnership strategies for banks
• 15:26 — How to “flex” or “unbundle” a bank balance sheet
• 20:30 — Entering a new era: leader priorities
• 20:57 — Adapting strategies to respond to industry transformation

Conclusion

The episode offers a candid, data-driven look at how banks must rapidly transform to stay competitive—rethinking balance sheets, investing strategically in technology, partnering across the evolving ecosystem, and fostering resilient risk and organizational cultures. The next era will challenge established models, but also open up new opportunities for those who adapt quickly and smartly.