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A
Happy holidays to you from us here at McKinsey. Today, we've got one of our most popular interviews from 2025. We'll be back January 8th with new episodes.
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This is the McKinsey podcast where we help you make sense out of our world's toughest business challenges.
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Welcome to the show. I'm Lucia Rahilly. And I'm Roberta Fassar.
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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.
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That's McKinsey senior partner Pradeep Patiya. He leads our global digital financial services and he joins me and McKinsey senior partner Klaus Dalarip to discuss what banks need to do to stay vital in a world in flux. But first, despite some challenges, M and A markets are thriving. Read about it in our annual M and A report. In another report, affordable housing in the US It's a major issue and more of it would increase jobs and improve quality of life for many Americans. Check out more details in our Investing in housing report. And now let's Hear more about McKinsey's annual global banking Review. Klaus Pradeep, welcome to the podcast.
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B
Thank you. Looking forward to it.
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C
Thank you very much.
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A
I love that your latest annual review of the banking industry starts with what is possibly an Oscar Wilde witticism. And that is quote, everything's going to be fine in the end. If it's not fine, it's not the end, unquote. I like a little wit with my wisdom 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.
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B
Pradeep, you hit the nail on the head on the veneer. Banking is an extraordinarily important, critical and on the surface, successful industry, and those are three important words. It's important because it basically lubricates commerce. And it's been successful because if you look at the numbers on the surface, banking by nearly any measure, 400 plus trillion of assets intermediated by banks globally, $7 trillion in revenue globally, which is larger than nearly any industry. One and a quarter trillion in net income globally. So you look at all these numbers and you say, boy, that's a big leviathan and seems to be doing well. There's a lot of good news.
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C
Klaus, I think what is Working right now is interest rates and the net margins are just much better than they used to be. That helps the banks perform better. They get something out of the balance sheet that they have. And that dynamic is much more healthy now than it was five years ago. I think it's also an industry that has figured out what is less risky assets. And how do we make sure that that's what is on our balance sheet. So the banks are to a large extent healthier than ever in many dimensions. And that is seen in the financial performance of them. And that's something that the industry can be proud of.
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A
Let's turn now to some of the reasons then that 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 Genai to have changed that calculus for the better. Talk to us about why productivity is a source of concern.
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B
This was one of the disturbing things when Klaus, me and a number of our colleagues dug into the data. 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. And this is a bit disturbing actually, because if you look at professionals and technical services, productivity is up by 25% over the same period. If you look at non farm private businesses, it's up nearly 15%. And banking is actually down 4%. Two things that have happened. Number one, banks have gotten bigger. You go down the scale curve, you would expect productivity to get better. And two, banks have spent an awful lot and continue to spend an awful lot on technology. To be specific, banks globally spent $600 billion, give or take, on technology that's larger than the high tech industry spends on technology, despite scale having been thought of as the panacea, and technology spend having been thought of as being able to deliver the productivity. The data does not support that.
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A
So talk to us about what's going awry there.
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C
Banks have been technology companies for a long time, all right, so they were some of the first ones to really embrace technology and use it. But that also means they have a lot of legacy technology. The technology is going very fast, but most banks have been built 30, 40, 50, 70, 100 years ago. So their legacy is very deep. And that's also why the spending is big. It does, however, mean that when you look a bit ahead of what some of the markets think about, they don't value that legacy. They value what comes in the future.
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B
I think, as Klaus said, there's one other added point which is banking for the most part has been a case of and not a case of. Or in other words, when ATMs came along, it's not like you got to shut down branches when mobile came along. It's not clear that in most markets you can save by shutting down other distribution channels. So it's been this notion of escalating ands, and barring a few markets, there are very few cases where that spend has actually been an or. That is I invest in this and therefore I don't have to do something else because most checking accounts are still opened in branches in the United States. And so it's not like you cannot have branches. That's not a viable strategy at this time.
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A
So Klaus, you alluded to the future. 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 time? Do you see it occupying a smaller and smaller portion of bank's business?
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C
I think that 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 for humanity. However, it doesn't need to come in the same approach as branches have done in the last many years. I think that very much depends on the markets, the bank, the technology.
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A
We used to joke about retail banking publications and the headline the Retail Branch is dead. Long live the Retail Branch.
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B
Well, banking as you know, has been since the Sumerians, since nearly the very beginning of human civilization. And in fact banks have continued to be the conduit that has helped civilization progress. So anyone who claims that banks or banking is dead have truly got their head stuck in the sand because that is clearly not the case. Also I might say the industry structure. So the U.S. given we have 9,600 or so banks, when you count the 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 more limited single digit number of banks. So in the US the adoption of cash to digital has been slower than some other markets because it's a more vast country. So there's a bit of this prisoner's dilemma type thing where you can't be the last guy without a branch or the first guy without a branch when others do. There's a bit of this market moving in some unison that perhaps lengthened the decay curve of shifting to pure digital distribution compared to newer markets where they 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.
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A
And what about competitors like fintechs or big tech or other non traditional competitors and their incursion into more traditional banking territory? What's the state of play there?
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C
I think that depends a lot on if it's the big tech or if it's the fintech. There is a very nice defensive mechanism banks that is regulation, it's very complicated. And that means that if you are a big tech you will always think about am I equipped to going into a highly, highly regulated space like this? And some of them are and some of them are less Versus if you go to the fintechs they are to a large extent starting to think about how do I redefine the path of banking? And they've redefined the path. How do I create a better experience and how do I make that experience better? That the universal banks deliver when they have to deliver it in the branch, in the call center, in even in online banking, even remotely. And some of them have shown that they can. And it's also very clear that the markets value models that they fundamentally believe will scale and be more profitable and thereby have a more unified model. We've seen lots of fintechs that have scaled across the global that can either be in some of the big markets or across markets, typically not with a full offering but with a slimmer offering that is then attractive for a smaller group. But they get scale by being in multi markets or being in very big markets. So that's definitely happening. I think that's just another great learning opportunity. I think the fintechs are pushing to an industry to become more modern, more effective and more customer friendly.
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B
Banks are the ultimate fintechs except it's with a capital F small T. I would say the actors that you might be more worried about is small F capital T. These are the large tech giants that have massive customer basis, huge investments and understanding of technology. And if they start leveraging that customer position, the data they have, the distribution, they have to start getting into small F finance which is they don't want to do all the heavily regulated, painful stuff. But if you start taking off the attractive pieces of finance, of banking, that is something to contend with. So I'd be worried about that perhaps versus a lot of the attack of fintechs that think they can take on a banking industry that's largely proved to be a fool's errand. There are a few breakouts, but those are truly few and far between.
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A
How do you think about other kinds of attackers from within financial services, wealth management or private credit, for example, besides.
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B
Productivity, besides the fact that banking is somewhat hard to disrupt business, the most attractive parts of banking, wealth management, payments exchanges, information related businesses like ratings, those are the ones where banks have had to cede ground to wealth managers, insurance companies, private equity players, and those are the businesses that have very high multiples. So 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. So it's all of the above.
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A
Let's turn now from these challenges to what banking leaders can actually do to achieve, as you call it in the report Escape Velocity. And run counter to the skepticism, how should leaders be grappling with the question of where to compete?
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C
I can look for scale advantages and I can look to expose myself towards some of them ingrained, more profitable markets. We can also double click a bit on that and say even within the market you can go down to customer and segment level and see that some segments are more profitable than others. So the investment heavy segments, private banking, affluent banking, are more interesting than the everyday banking customers that this basement has a payment account, at least if you're an universal bank. The paradox of course, if I build infrastructures that scales across markets, so if I'm a payment infrastructure, then I can make something that creates massive scale across markets and therefore I get highly valued for that because it's a technology and it's a platform that I can scale multiple and therefore I don't have to build it in every market.
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B
Number one, certainly don't ignore locations where there's actually rising tides. If you miss that, you end up missing a big boat. Two, don't ignore demographic shifts. I think in terms of the specific businesses, what's happening to the demographic shift? Banks should be well positioned as people age, as there's wealth transfer that happens over the next decade or two. Otherwise they would cede ground to asset managers, wealth managers, insurance companies and so on. Right. The third thing in terms of where to compete is this notion of businesses to be in versus not, which is the business mix question. So being very deliberate in terms of where you're competing and what percentage those businesses make up versus the others is a deliberate act. Being a lot more purposeful has been a key factor in determining the 14% of banks in our data set that we talk about. That really did better and outperformed on returns and growth.
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How are they addressing how to win then? How are successful banks in this 14% cohort gaining and maintaining an edge from execution?
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We call it management quotient in aggregate. If you look at it, we use the term mq and this is a little bit of all these different ingredients that make up management quotient. 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 just the sheer metabolic rate of execution, which is the discipline. Now most banks talk about having moved to an agile model. In reality the data would show that it's probably 20% agile, 80% non agile. Still, because agile is a way of working, it's in pricing, it's in distribution, it's in finance, it's in hr, it's in marketing. And less than one in five banks can claim to have moved to agile if you define it by that standard. And then the third is the businesses that have high fees, high roe type profiles, largely fee based businesses. It's not easy to get into those because you have gorillas in those businesses too. So what's the angle for banks to gain ground in wealth and payments, for example, in an industry structure, I'm speaking for the U.S. for example, where you've got very large entrenched players and so many banks have struggled to win in wealth management because it's a difficult, non obvious play, just repeating the playbook may not yield. And then I think I would add a fourth which is technology because it's such a big part of where banking is going to go, really being thoughtful of how you're going to spend and where you're spending to get the most bang for the buck, particularly as it relates to tech.
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A
Do you see talent intersecting with tech as a factor? We hear a lot about scarcity in the talent markets generally and then that's exacerbated given the fast changing tech landscape and skill shortages and up to the minute technologies.
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C
This whole notion of the banks is that you actually have been a tech company always. So you have to fight for the best talent. And now comes the complicating fact, it all goes a bit slow. Banking doesn't completely revolutionize itself in 12 or 24 months. And that means that when you get to the talent place, you want the best talent. You need to have those that can both think strategically. You need to have those that can both execute. You need to have them that definitely lean out on new Technologies, but it goes a bit slow. That's the battlefield. But then the banks have a real task of telling people what the exciting things are and why this is important. But people can't see the difference in a quarter or in the next quarter. In the next quarter. But over a few years, they can see a real difference.
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B
It's like that famous joke which talks about two chaps out camping and there's a bear and one guy starts running. The other guy starts bending down to wear his running shoes and the other guy says, are you mad? Why aren't you running? The guy says, I just have to outrun you. I don't have to outrun the bear. So this is the story of banking right now. Banking has generally been the recipient of good talent relative to many other industries. It's an attractive, quote, unquote, sexy industry to be in. The problem is that in the more recent times, the competitors have changed. It's now the wealth managers, it's the tech companies, it's the sexy payments players. It's a bit of stepping down to wear your sneakers so you can outrun the other chap. You don't have to outrun the bear.
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A
I want to pull back momentarily from industry dynamics and take a look at rising volatility in the global macroeconomic landscape. Geopolitical tensions are obviously burgeoning. Uncertainty is rising in the throes of all this change, how should banks be preparing themselves for potential shocks to the global financial system?
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B
This is the question du jour. So first off, I would start by saying 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. And this could be a local bank, it could be a global bank. Doesn't matter. I think this is something that should be on the agenda for, for nearly every bank because lots of things appear to be in motion, in flux, in change, and these will create great opportunities as well as great risks, whether you're a local bank or you're a national bank, or you're a global bank. Now you look at some of the variables in play. Are we retreating from more global to more multi local or even national? Does that create opportunities for certain kinds of banks? So this is just the mix of where it's gonna shift based on macro has to be considered and thought about. The second thing is there are certain sectors, whether it's crypto, whether it's cannabis, these are all things that actually banks have largely been out of. If these were to get regulated and more open to banking. What opportunities does that create for banks? Third, some nations have talked about CBDCs, central bank, digital currencies. That can both be great and that can also be a huge threat for banks in terms of the core business of banking. You can basically disintermediate banking, even though banking is supposed to be the intermediary between lenders and those who need the capital. And fourth is, I would add, the risks that come with big tech AI, quantum computing, which has the risk of exacerbating massively cybersecurity risks and cryptography and so on.
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A
Klaus, anything to add there?
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New banks can be built from scratch with half the ingrained cost of the incumbent banks. That of course means that there's certainly a trade off here. Do I build a new bank or do I maintain on the old bank? Which I think is a great example for most banks to stick down and reflect on that. And I think that notion is going to be very important and especially in the world that we live in now with both technology, geopolitics, everything that's around is that how fast can I adapt to those changes?
- [21:54]
A
Pradeep, you mentioned cryptocurrency. Anything more to say on how crypto might disrupt dynamics in the financial markets in future?
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B
We do need exchanges that help facilitate price discovery, transparency, custody, so that you actually don't have people that don't have the money when they want to sell and so on. Right. I think largely most banks and tech companies and observers would agree that blockchain as a fundamental technology and a capability is a yes. Now you get up to the specific quote, unquote apps, the coins and the exchanges on which those coins actually are traded. So exchanges, I've always believed will be a good business because you're market making effectively. Let's assume that 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, I think that's actually a good business. The piece that people have a debate on is this question of what purpose does the Bitcoin when it's used in a speculative way have? What is it actually doing? I'm actually of the belief that we should experiment, we should do it carefully. And let's be clear what we're talking about when we talk about cryptocurrency.
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A
Klaus, looking out over the next, say five years, 10 years, what will investors value?
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C
We start with the people, as in the customers. I think there's no doubt about that the whole notion, if you start at individuals, we will increasingly so expect personalization. So if we go back to the conversation we have with the branches, kind of in the old days, the person that understood you, that knew who your kids were, knew what you needed before you needed it, that would call you and say, listen, you can save some money. You're not saving enough to retire at the age that you want. Hey, you're not well enough insured given the wealth you have, that personalization will increasingly so become important. And the expectations is also that we get help with more and more things. So not just hey, your overdraft is now over or your loan is running out, that's the individuals versus corporates. They will increasingly expect the banks to take care of them. We expect you to have a perspective on how I best manage my risks that I don't trade with companies that could potentially go bankrupt. We expect you to provide advice on what type of ERP system should I buy that will integrate nicely into you so that I don't need to spend as much time and money on my bookkeeping. So there's clearly an increasing expectation which for some banks will take them outside of the core banker. We then look at investors. Investors will value models that scale easily and that means that you either grow on your top line but keep your cost stable. That can be cross border, that could be the in the country, that can be multiple markets. And if that scalable model then also doesn't require you to get more capital, which is also part of the scaling, then that's an added benefit. But luckily these two things can coexist.
- [25:25]
A
Klaus and Pradeep, great discussion. Thanks so much for joining us today.
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B
Thank you. It's a pleasure.
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C
Thank you. It's our pleasure.
- [25:33]
A
Thanks so much for listening to the McKinsey Podcast. I'm Lucia Rahilly. And I'm Roberta Fassaro. Find us on McKinsey.com, we'll have a transcript of this episode up shortly and download the McKinsey Insights app where you can find this podcast in words, other Other helpful content updated daily. If you enjoyed the show, we'd love for you to leave a rating and a review. We'll see you in two weeks.