Banking & Securities

The next normal

Banking after the crisis

March 2010
Tab Bowers
Olivier Hamoir
Anna Marrs
Max Neukirchen
2

Contents

The next normal: Banking after the crisis

Introduction 1

Planning for the long term 1

Six disruptions 4

Thriving in the ‘next normal’ 10


The next normal: Banking after the crisis
Introduction
At the risk of stating the obvious, the recent financial crisis
has ushered in a period of immense uncertainty. Following
widespread problems in 2007 and near-death experiences in
2008, some businesses enjoyed an abrupt recovery in 2009.
Amid this intense confusion, banking leaders have rightly
focused on survival. But despite ongoing ambiguity about
markets, risk, regulation, and demand, they should have little
doubt about one thing: long-term structural changes to the
industry are being forged in the crucible of the crisis.
The time is right to begin the debate about the nature and
effect of these permanent changes. To that end, we have
conducted research and interviews, and drawn on our work
with leading institutions throughout the current crisis, to
form an early understanding of the fundamental changes
that will affect banking in the years to come. To start, we
researched bank results over the past several decades.
We then conducted proprietary “momentum” analysis on
25 global banks to see how various portfolios of banking
businesses and geographic distributions would behave under
different macro and regulatory scenarios, based on the recent
work of the McKinsey Global Institute (MGI). And we have
collaborated with many banking leaders to compare our
findings with their field-tested understanding.
When we took apart the constellation of forces and events that,
together, made up the crisis, we identified the following six
fundamental changes:
ƒƒ Returns in the future will be highly uncertain. In one
of the two most likely scenarios, returns grow by a
surprisingly vigorous 5 percent through 2014, even
after taking into account the impact of more stringent
regulation. In the other, returns grow by only 1 percent.
ƒƒ The range of performance by banks using similar business
models will widen. Big European banking groups, for
example, will see ROEs ranging from 9 percent to 18
percent.
ƒƒ Margins will again start to compress. Early evidence
suggests that the crisis-generated rise in margins will
prove to be a blip in most businesses. As competition
returns, margins will resume their historical trend.
ƒƒ Within a few years, we will no longer call markets that
1
are currently new “emerging”; such regions, especially
in Asia, will not only have fully emerged but will create
most of the value in the industry. In one plausible
scenario, revenues in China and India will grow about 10
percentage points faster than in North America.
ƒƒ Capital is likely to remain scarce for even longer than
many now envision. Emerging-markets giants, in
particular, will hunger for new capital to fund their
growth, but they will probably be able to collect just half
of their future needs through retained earnings.
ƒƒ Finally, the funding issues that started the crisis for
many banks will persist, with funding scarcity and cost
continuing to take a heavy toll on profits in coming years.
We estimate that a 50-basis-point rise in the cost of long-
term funding will cut up to 2 percentage points from ROE
for some banks.
Continued industry uncertainty will breed opportunity
for some, and more losses and a decade of cost cutting for
others. A few leading universal banks are already reviewing
their group strategy to harness the opportunities these
shifts present and to avoid the pitfalls they expose. A three-
part agenda of strategic actions, business-unit moves, and
organizational changes can help big banks succeed in the next
phase of the industry’s evolution.
Planning for the long term
It will surprise many to learn that for much of its modern
history, banking has only just returned its cost of equity—and
for long stretches, has fallen short even of that (Exhibit 1). We
analyzed several hundred European and US banks’ returns
from 1962 to 2009 and found that until very recently, returns
hovered around breakeven of 11 percent cost of equity. Only
in the late 1990s did industry average returns move decisively
above the cost of equity, where they then stayed (the tech bust
of 2001 being an exception). Many bankers, having grown
up in the industry during this anomalous ten-year period,
assumed that banks had always earned extremely attractive
returns—and that they would continue to do so in future.
Although the crisis seemed at first to demolish this
assumption, more recently the recovery has seemed to
confirm it. Bankers, understandably suffering from a bit of
2

EU banks
Exhibit 1 US banks
Average (by decade)
An anomalous banking industry COE3

decade ROE levels of “normal” industries

ROE1 for European and US banks2,1962–2008 such as utilities, retail, etc.

Banking returns have %

Banking ROEs fluctuated among ROEs climb
hovered around cost sustainable “normal” industry levels up to
of equity – except in 20%+ peak
the past 10 years. 25

20

15

10
Ø 11%3

0
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2009

-10

1 Operating ROE, ie, net income as percentage of equity excluding net goodwill
2 Based on consolidated financials and valuation over time of 113 EU banks, of which 107 are still active; and 957 US banks, of which 346 still active
3 Average historical cost of equity for developed-market banks was calculated for each decade using a market-risk premium of 5%, the end-of-year risk-
free 10-year Eurozone government swap rate, and beta, based on the 3-year average beta of the European banking index

Source: Compustat; Datastream; Bloomberg; McKinsey Future of Banking model

whiplash, are suddenly less sure about the future. As a result,
many have forgone their usual long-term strategic planning,
instead training their lens on the next 6 to 12 months. From
that near-term vantage point, the view does not look good.
Many believe that impairments from lending operations have
not yet peaked, suggesting that the coming year may prove
worse even than 2009. And while valuations for banking
businesses have improved—indeed, they could hardly have
fallen further—many banks will find themselves having to
sell noncore operations at substantial losses versus book
value. Thousands of branches and dozens of other assets,
such as structured finance businesses, are likely to be sold.
McKinsey’s corporate finance practice estimates that in
Europe alone, up to €1 trillion of banking equity will be sold
during the next two years, much of it to new entrants from
outside the industry. While the final number is subject to some
uncertainty, it will be massive.
Taking a short-term view may seem to afford banks stabler
footing as they navigate shifting ground. But if the crisis has
indeed caused a paradigm shift—a term that, if overused, may
be truly applicable here—then banking leaders must restore
a long-term strategic horizon of, say, five to seven years and
search out the new arc of the industry. Although uncertainty
still reigns, it has sufficiently dwindled for many institutions
that they can once again take a longer-term view.
A long-term, multivariate view
To aid in that planning, we have turned to the scenarios
developed by the McKinsey Global Institute and tested with
executives in dozens of industries.1 We have collaborated

1 For more on MGI’s scenarios and how industry executives have rated them, see “Economic conditions snapshot, December 2009” at
mckinseyquarterly.com. In January 2010 MGI issued an update to its scenarios that fine-tunes the analysis for current market conditions but does
not change the fundamental findings of our modeling. For more on the updated scenarios, see “New Economic Scenarios for 2010: The Global
Economy Has Stabilized. Is a Return to Growth Assured?”. For more on scenario planning, see “The use and abuse of scenario planning,” (Charles
Roxburgh). All articles are available at mckinseyquarterly.com.
Banking & Securities
The next normal: Banking after the crisis 3

with MGI to adapt these scenarios, which describe macro- intervention, such as new capital requirements, consumer
economic uncertainties about growth and inflation, to protection measures, new rules on risk management, pay
include the particular forces that most shape banking profits: caps, and the extension of regulation to the “shadow” banking
the shape of the yield curve; and uncertainties about state system (Exhibits 2 and 3).

Exhibit 2
Considered scenarios Plausible scenarios
Two scenarios Macro
uncertainties State intervention uncertainties

Two scenarios are Ineffective

Description
the most plausible ▪ Depth and duration of the
combinations of new Macro
uncertainties
global recession?
– Economic growth:
regulation and the developed vs emerging
markets
pace and depth of – Inflation and shape of
interest rate curve
economic recovery.
State ▪ Timing and magnitude of
intervention regulatory changes?
uncertainties – Capital requirements
– Consumer protectionist
measures
– Requirements on risk-
management practices
– Regulation of near-
banking institutions
regulation
Moderately Overly safe
tighter regulation regulation
Quick fix
Strong growth
following short
downturn
Battered, but resilient
Prolonged recession
followed by growth to
Midpoint
case
pre-crisis level
Stalled globalization
Recession followed by Extreme
structurally slower case
global growth
Long freeze
Long-term downturn
▪ Prolonged recession followed by ▪ Recession followed by
subtrend growth to pre-crisis level structurally slower global growth
▪ Markets for all asset classes recover ▪ All markets remain dysfunctional
▪ Regulator aspires to stabilize the ▪ Regulator views banks as
financial system utilities, limiting industry returns

Source: McKinsey Global Institute, McKinsey Future of Banking model

Exhibit 3
Moderately tighter regulation Overly safe

Regulatory ▪ Regulator aspires to stabilize system and lower ▪ Regulator views banks as utilities, limiting
risk exposure of lending institutions returns and growth
assumptions ▪ Transparency and improvement of risk- ▪ Consumer protection, long-term volatility
management practices are key goals reduction are key goals
Two reasonable ▪ Targeted regulation of only “systemically ▪ Strict regulation of both systemically important
important” institutions, including pay caps, institutions and smaller banks: pay caps, capital
estimates about regulation of exotic products, tighter capital rules, rules, product regulation/standardization
tougher lending standards
the shape of future
regulation. Intensity of regulation in 2013E/2014E1

Capital reqs.
8% 12% 8% 12%
for RWA

Increase in
0% 200% 8% 200%
market RWA

Tier 1 ratio2 4% 12% 4% 12%

Core Tier 1
2% 10% 4% 10%
ratio2

Leverage
25x 15x 25x 15x
ratio3

1 Slightly higher in emerging markets

2 An extra buffer of 1% in the “moderately tighter regulation” and 1.5% in “overly safe” is included
3 Leverage ratio = assets/equity
Source: McKinsey Future of Banking model
 4

Combining the MGI macroeconomic projections with the two
regulatory outcomes produced two potential and plausible
scenarios:
ƒƒ The midpoint case is characterized by prolonged
recession followed by subtrend growth to pre-crisis
levels. Markets in nearly all asset classes recover as
regulators seek to stabilize the financial system, improve
risk-management practices, and increase transparency.
Moderate regulation of systemically important banks
includes pay caps, new rules on exotic products, and
tighter capital requirements. Under this scenario, banks
will be required to maintain a Tier 1 ratio of 9 percent and
a core Tier 1 ratio of 7 percent. The volume of market risk-
weighted assets will increase by about 150 percent before
any mitigating actions by banks.
ƒƒ The extreme case, in contrast, sees a moderate recession
followed by structurally slower global growth. Markets
remain severely dysfunctional. Regulators see banks as
utilities, not independent agents, and seek accordingly to
limit their returns and suppress volatility. Strict regulation
is applied not only to systemically important banks but
to smaller entities as well. In this scenario, banks would
face much tighter capital requirements: a Tier 1 ratio of 12
percent, a core Tier 1 ratio of 10 percent, and an increase in
market risk-weighted assets of about 200 percent, again
before mitigation.
We then applied the scenarios to 25 global banks (Exhibit
4). Together, these banks represent about 40 percent to 45
percent of global industry assets and all the major Western
and emerging markets, including Brazil, Russia, India, China,
and Eastern Europe. We divided them into five archetypes:
three kinds of universal bank (North American, European,
and Japanese); emerging-markets giants; and global
investment banks.
Six disruptions
Our model presents a kind of “run-rate” forecast: a picture of
the future of these institutions if management takes no action.
When we look at this picture, we see six genuinely significant
changes—the biggest factors against which management
should act to preserve future profitability.

% of total market cap*

Exhibit 4
Number of banks
% of total assets*
Five archetypes
The 25 banks studied Global spread
fall into five groups.
North America Europe Japan Emerging markets

A B C E
European Japanese Emerging-markets
North America
universal universal giants:
universal banks:
banks: large global banks: large global more than 60% of
Universal

large global banks

banks with EU HQ banks with JP HQ total net revenues
with NA HQ and
and more EU and more JP in emerging
more NA business
business business markets
Business focus

30 28 6 26 34 7 6 17 4 32 16 6

Global IB banks:
>65% of total net
IB-focused

revenues in IB; with

global focus

6 5 2

* Total market capitalization of the 25 banks studied as of October 2009 was $2.3 trillion. Total assets as of June 2009 were $31.2 trillion
Source: Bloomberg; bank Web sites; McKinsey Future of Banking model
Banking & Securities
The next normal: Banking after the crisis 5

Uncertain returns: Bad and less bad
In the eyes of banking leaders, the midpoint and extreme
scenarios are equally likely. But their effect on the industry
would be anything but equal. In the midpoint case, industry
revenues would grow at 5 percent annually through 2014;
in the extreme case, the industry would eke out a much less
attractive 1 percent annual growth (Exhibit 5).
The two scenarios also present an imposing divide for the
five archetypes of banks in our model. Under either scenario,
the emerging-markets giants come out on top, with an ROE
in 2014 of 18.1 percent in the midpoint case and 9.4 percent
in the extreme case. The story for the other archetypes is
mixed. In the midpoint case, the US and European universals
and the investment banks would generate middling ROEs
of around 15 percent, well below their pre-crisis levels of
more than 20 percent. Japanese universals, laboring in a
poor macroeconomic environment, would produce an ROE
of 7.1 percent. In the extreme scenario, all but the emerging-
markets giants will find it extraordinarily difficult to return
even their cost of equity. In other words, these banks will face a
challenging period reminiscent of the early 1980s (Exhibit 6).
Our estimates may be conservative. We did not include,
for example, the effects of a liability levy like that recently
proposed by the Obama Administration. Instead we modeled
this separately, and found that if such a tax were adopted
globally and imposed on the banks in our model the effect
would be to reduce banks’ ROE by between 0.7 and 1.2
percentage points. The uncertainty about returns creates
enormous downside risk for the banking sector. Investors will
continue to be wary, further capital raising may be difficult,
and cheap wholesale funding may be a thing of the past. As
regulation accounts for a large part of the uncertainty, a new
approach to regulation—from interacting with regulators
to interpreting new rules to understanding their impact on
businesses—will play a crucial role in CEOs’ agendas.
Widely disparate returns
Archetype is to some extent a form of destiny: emerging-
markets giants, riding the back of faster GDP growth, will
outperform developed-market universals. In many ways,
banking is a leveraged bet on the underlying economy.
But within that destiny, banks have a lot to say about their

ROE
Exhibit 5 Asia
Europe, the
Two roads diverged Middle East,
Total revenues before risk costs and Africa

Returns in the two $ billion Americas

most plausible
Midpoint Extreme
scenarios will be
widely different.
+5% p.a. +1% p.a.
1,461
1,408 1,140 1,128 1,147 1,146 1,149 1,171
1,400 1,349
1,267 1,018
1,182 28% 29%
1,200 1,140 25 25
904
1,0181
1,000 24% 20 20
9041
28%
ROE

ROE

800 15 15
29% 27%
%

600
10 10

400
44% 5 5
47% 44%
200
0 0
0
0
2007 08 09 10E 11E 12E 13E 2014E 2007 08 09 10E 11E 12E 13E 2014E

1 Revenue for 2007 and 2008 is pro forma, ie, it includes results from banks acquired by the banks in our sample in 2008 and 2009

Source: Analyst reports; McKinsey Global Banking Pools; McKinsey Future of Banking model
 6

Exhibit 6 Emerging-markets giant European universal banks

ROE for five archetypes, 2006–14E Global IB banks Japanese universal banks
Going their several % North American universal banks
ways
Midpoint Extreme
ROEs for the five
archetypes will be 30 30
widely disparate. 25 18.1 25

20 16.0 20 9.4
14.0 7.9
15 15
13.6 8.0
10 7.1 10
7.1
5 5 1.5
0 0

-5 -5

-10 -10
-30 -30

-35 -35
06 07 08 09 10E 11E 12E 13E 14E 06 07 08 09 10E 11E 12E 13E 14E

Source: McKinsey Global Banking Pools, McKinsey Global Capital Market Survey, team analysis, bank Web sites,
McKinsey Future of Banking model

performance. In the future, we will see significant differences
within archetypes. Even in our model, which extrapolates
current performance to present a stable, “run-rate” view
of the world, we can see these differences. Of course, there
have always been differences in performance among banks
playing largely the same hand. But the crisis has considerably
ratcheted up economic volatility, putting an end to the period
some have dubbed “The Great Moderation.” This volatility
will amplify the existing differences in performance. Exhibit
7 shows the range of widely disparate returns we expect to see
in 2014.
Some of this is already apparent in banks’ results for Q4 2009:
strong players are reporting substantial earnings, while
others are still working through write-offs and accounting
events that have turned earnings negative. In the future, we
expect more of this variability, driven by portfolio mix. Banks
that are heavily skewed toward corporate or retail banking
in deleveraging economies, such as Spain and potentially
the United Kingdom, will come up short.2 Among European
universals, for example, those differences will equate to
about an 18 percent ROE in 2014 for the best performer, and
9 percent for the worst. To take another example, some banks
are much more able to respond to the exigencies of the crisis
than others. State-owned banks, for instance, obviously
have many fewer degrees of freedom to pursue “step-out”
opportunities such as investing in Asia. National regulators
are increasingly wary about wards of the state deploying large
amounts of capital outside home markets.
This variability has two additional implications. First,
investors will find it even more difficult to understand large
banking groups because the performance of the entities
within those groups will be so variable. Second, group
managers will have an even greater ability than before the
crisis to determine performance, through the choices they
make about business models and, to a lesser extent, geography.
Some managers mistakenly believe that the nature of new

2 For more on the effects of deleveraging on national economies, see “Debt and deleveraging: The global economic crisis and its economic
consequences” (Susan Lund, Charles Roxburgh, et al.), www.mckinsey.com/mgi.
Banking & Securities
The next normal: Banking after the crisis 7

Exhibit 7 Min Avg Max

Variability even ROE in 2014E

within archetypes %
Midpoint Extreme
Archetype may be
destiny, but banks 0 5 10 15 20 25 0 5 10 15 20 25
have some say in the
matter. Emerging- 13 18 24 6 9 12
markets giants

Global
10 14 18 4 8 12
investment
banks

North American 11 16 20 4 8 12
universal banks

European 9 14 18 4 7 10
universal banks

Japanese 5 7 9 -2 2 3
universal banks1

Source: McKinsey Global Banking Pools; McKinsey Future of Banking model

regulation will be of little concern, since whatever the new
rules are, everyone will have to play by them. But they would
be far better off recognizing that the new rules will affect
various banking businesses and regions in very different ways,
and that it will be better for banks to be big in those areas that
are least adversely affected.
The permanent return of price competition
Many industry analysts, and not a few banks, have rejoiced
at the greatly improved margins in 2009 and have come to
see them as the new standard (Exhibit 8). To explain this
phenomenon, they point to the lower level of competition,
stemming from the departure of some banks and the
retrenchment of others, as well as to the view that the many
state-aided banks may be less assertive than they would
otherwise be. This camp believes that risk is finally being
priced adequately into banking products and services, as
well as the higher capital requirements to come—and that
customers understand and accept the need to pay for this risk.
Finally, in this view, new compensation schemes that reward
profitability and not just volumes will also play a part in
keeping margins fat.
Regrettably, the case for the margin skeptics is stronger. As
noted, the next two years will see a substantial number of
forced or semi-forced sales, likely at a book value of up to €1
trillion, either to banks on sounder footing or to new entrants
such as private-equity firms or retailers. Competition may
also enter Western markets through the back door, as it were,
as newly dominant emerging-markets banks take positions
in developed markets. Finally, if incumbents as well as new
entrants act with unprecedented discipline and keep prices
high, we believe national governments and regulators will
shift their focus more firmly to pricing (which is the main
regulatory focus in utility regulation, for instance).
Already we see evidence that margins are peaking. Fees for
debt issuance have come down substantially, as have margins
in foreign exchange. The bid-ask spreads on certain USD/EUR
products peaked at 6 basis points (bps) at the end of 2008.
As liquidity concerns diminished through 2009, the spread
has returned to its long-term average of 3 bps. In some Asian
markets, such as Hong Kong, fee competition has reached the
point where advisers barely break even on transactions. To be
sure, some businesses, such as commercial real estate finance,
may indeed have attained more or less permanently higher
 8

Exhibit 8 Italy
Germany
Recent repricing France
Margins for new business in Europe
has been Spread over Euribor Spain

successful % Eurozone

A crisis-induced blip in 4

margins. 3
SME loans
2
(less than €1 million)
1
0

4
3
Large corporate
loans 2
(more than €1 million) 1
0

4
3
Residential
2
mortgages
1
0
2003 2004 2005 2006 2007 2008 2009 Q3
09

Source: European Central Bank; Bloomberg

margins. But most will return to the historical downward
trend.
The markets formerly known as emerging
As has been obvious for some time, the crisis affected
emerging markets, and especially Asia, less severely than
Western markets. Parts of Asia were the last to enter into
recession and the first to emerge—indeed, China’s economy
never stopped growing. Asian banks had less trouble with
toxic assets and excess leverage than their counterparts. The
crisis served to demonstrate that the balance of power shifts
not gradually but tectonically; many Asian banks have vaulted
to the top of league tables all in one go.
Our dataset includes banks from most of the big emerging
markets: China, India, Brazil, Latin America, and Russia.
The story across these markets is broadly the same and is best
exemplified by the Chinese and Indian banks we studied.
Our research confirms that for the next several years, Asia’s
economic might will continue to grow, as will the influence
and power of its banks. Indeed, in these markets, banking is
likely to grow much faster even than the broader economy,
because so much of the population is “unbanked.” Exhibit 9
shows that India and China will see extremely rapid growth in
the midpoint scenario. And in both scenarios, all the emerging
markets will grow substantially faster than the more mature
markets of Europe and North America.
That said, investing in Asia is not at all straightforward. We
estimate that just 33 percent of Asian (ex-Japan) revenue
pools today are accessible to foreign banks, mainly because
of regulation. Some markets, such as Singapore and Hong
Kong, are entirely open—though this has been true for some
time, and these markets are small. The bigger prizes, such
as mainland China (25 percent to 30 percent accessible) and
India (10 percent to 15 percent), are much more challenging for
Western banks to capture. Not only is access limited, but even
when attackers manage to gain a foothold, their economics
do not compare favorably with state-owned incumbents. In
India, state-owned incumbents had faster profit growth from
2005 to 2009 than new entrants (42 percent to 26 percent) and
higher ROEs (18 percent to 16 percent). The story is much the
same in China.
Banking & Securities
The next normal: Banking after the crisis 9

Exhibit 9
Net revenue growth, 2009–14E
Asia advances CAGR, before cost of risk
%
India and China will
thoroughly outperform Midpoint scenario Extreme scenario
in either scenario.
India 16.3 6.5

China 12.8 9.2

Russia 10.2 4.4

Latin
8.3 0.3
America

Europe 3.3 -0.6

North
3.1 -2.4
America

Japan 2.2 -3.0

Source: McKinsey Global Banking Pools; McKinsey Global Capital Market Survey; McKinsey Future of Banking model

Finally, we have not included political risk in our model, nor
have we accounted for some of the pressures building in the
Asian macro economy, such as the undervalued renminbi or
potential asset bubbles in some markets. Should some of these
risks become reality, then of course banks will be exposed. But
the broader trend will remain intact and far outweighs such
potential risks.
Capital: Thin on the ground
We modeled the capital needs of the 25 global banks in
our dataset, looking at how much they would need to fund
projected asset growth and meet regulatory requirements.
We also modeled their main source of new capital—retained
earnings—and assumed that 50 percent of earnings would be
paid out as dividends in the midpoint scenario and 30 percent
in the extreme scenario (Exhibit 10).
In both scenarios, absent any management actions, banks in
every archetype will require more capital. Their needs range
from the small (investment banks, which have already raised
significant amounts and are holding substantial buffers,
anticipating regulatory change) to the vast (emerging-markets
giants, which will need to fund their growth). In between are
the universal banks, which will have modestly challenging
capital needs in the midpoint scenario and a very challenging
problem in the extreme scenario.
In the extreme case, the 25 banks we modeled would need
to raise more than $600 billion of capital over the next five
years, equivalent to approximately 35 percent of today’s
capital base. While for the emerging-markets giants—with
their large capital need driven by growth—this may not prove
challenging, for developed-markets banks, with returns well
below the historical cost of equity in this scenario, raising
this much capital would border on the impossible. So what
would happen then? First, management would put a high
priority on optimizing a bank’s capital base, by exiting some
businesses and working through granular model changes and
capital-leakage reviews. If this proved insufficient, existing
“bad banks” would get bigger and more assets would be sold,
assuming buyers could be found—which, given the volume
of assets on the block, could prove difficult. That would place
the largest banks in the United States and Europe, their
 10

+... Total additional tier 1 capital

Exhibit 10 needed as of 2009E base, %

Capital remains Tier 1 capital supplies and requirements for 25 modeled banks, 2014E
$ billion
scarce Midpoint scenario Extreme scenario
Uses of capital Sources of capital Uses of capital Sources of capital
Capital needs range
from mild to severe. +52% +72%
Emerging- 84 215 147 218 211 204
markets giants 278 197

Global
+8% +16%
investment
banks 8 16
23 7 23 7 42 33

+24%
179 +3%
North American 58 296 212 151
220 18
universal banks 67

European +7% +28%

universal 253 162 134
62 135 37
banks 109 43
+11% +47%
Japanese
102
universal 23 124
23
42 33
banks1 14 1
Fund asset Meet Retained New capital Fund asset Meet Retained New capital
growth, regulatory earnings required growth, regulatory earnings required
2009–14E requirements 2009–14E 2009– 14E requirements 2009–14E

1 Minority interests are included in calculation of leverage ratio (total assets/total equity) to reflect difference in capital structure
Note: Extreme scenario assumes 30% dividend payout ratio; midpoint scenario assumes 50%
Source: Analyst reports; McKinsey Global Banking Pools; McKinsey Future of Banking model

shareholders, and the government (one and the same, in
several cases) in a very difficult position, with a shrinking
banking system unable to lend and equally unable to meet
regulatory requirements.
More expensive long-term funding
Several factors point to continued strains on funding over the
next five years. First is a shift in demand. As part of balance-
sheet restructuring and to reduce the risks that became
obvious in October 2008, many banks are cutting back on
short-term, unsecured funding (such as commercial paper)
and seeking instead to issue longer-dated debt. Demand will
also rise as the longer-dated funding currently on banks’
books expires and is renewed. Third, on the supply side,
government funding schemes will someday end. Finally,
the market will see greater competition. Governments are
increasingly the biggest competitor in attracting customer
funding, which will still be a good funding option though
no longer a cheap one. In the United Kingdom, for example,
the national savings scheme had the best deposit rate in the
market for most of 2009. Several treasurers we spoke to cite
2011 and 2012 as years of particular concern, a time when all
these factors will come to a head.
All this implies that the demand for long-term funding will
remain high for a very long time, and with this high demand,
higher prices will follow. Given the scale of the need for many
banks, long-term funding will become very expensive: our
model shows that for our 25 banks, an increase of more than
50 bps in the cost of long-term funding would shave 1 percent
to 2 percent off overall ROE. Funding will remain a significant
issue and driver of industry profits, long after the immediate
crisis has abated (Exhibit 11).
Thriving in the ‘next normal’
How will banks cope with the many changes roiling the
system? The crisis has helped them develop a long list of
new skills—stress testing, liquidity management, cost
containment, workout, and restructuring. Appropriately,
long-term strategy development has been pushed to the side.
But as the crisis pauses or subsides, the time has come to set a
Banking & Securities
The next normal: Banking after the crisis 11

As is + 50 bps + 100 bps

Exhibit 11
Costly long-term Effect on ROE of increased cost of long-term debt,1 midpoint scenario
funds will hurt %
17.8
profits 18.1
17.4
16.0
Banks’ dependence 14.9
13.8 13.6 14.0
on wholesale funds
11.7 11.4
will be hard to shake
9.9
and expensive to 8.8
maintain. 7.1
6.1
5.1

North European Japan Global IB Emerging-

American universal universal league markets
universal giants

Long-term debt Midpoint -4 -8 1 N/A +4

ratio evolution
2009–14E Extreme -5 -11 -1 N/A -9
%

1 An average debt duration of five years is assumed, implying that 20% of long-term debt must be refinanced every year

Source: McKinsey Global Banking Pools; McKinsey Future of Banking model

strategic agenda that will make the most of the opportunities
in the new world. The agenda should include three parts:
ƒƒ Strategic “top of the house” actions—strategic priorities
that the CEO and senior management team must drive at
the group level
ƒƒ Divisional and business-specific actions—changes that
business heads should make for the units they lead
US levy on banking liabilities, a surprise to most of the
industry, proves the point. The regulatory outcome, whatever
it is, is likely to be the largest driver of industry profitability,
once impairments and other one-off losses have abated.
Regulatory interaction must be one of the CEO’s top priorities.
Given this, regulatory strategy and management must change
from a decentralized and sometimes compliance-oriented
exercise to a core strategic discipline. To prepare for this,
banks should:

ƒƒ Organizational enablers to instill greater flexibility across
the institution—organizational adjustments that the CEO
leads to accommodate the significant uncertainties ahead
Strategic ‘top of the house’ actions
Improve regulatory strategy. Banking regulation has always
been something of an afterthought in strategy development.
Slow to change and rather predictable, regulation defined only
the broadest boundaries of banking activity. In the wake of the
crisis, regulation is no longer a single set of assumptions but
rather a highly variable set of outcomes. The newly proposed
ƒƒ Model the impact. As noted, regulation will affect
all banks, but it will not affect them in the same way.
Business mix, geographic mix, and institution-specific
attributes will determine the impact of regulatory change.
Understanding the differential between the effects on an
institution and its peers will help steer business decisions
and also help identify which of the “tsunami” of new
regulations are more critical for banks to understand and
anticipate.
ƒƒ Expand and enhance regulatory management.
Preparing for regulatory issues will remain time-

consuming: some banking strategy heads already spend up
to 50 percent of their time working with regulators—and
we believe this will continue to prove true for some time.
In 2010 and beyond, regulators might have literally
hundreds of touchpoints at the largest banks—across legal
and compliance, regulatory affairs, treasury, finance,
and other areas of senior management. Given how long it
is taking for new regulation to come into effect—and how
complex that regulation is likely to be when it arrives—
banks need to expand their central coordination and
project-management capabilities.
ƒƒ Manage regulation globally. Although for most banks,
seamless global coordination across regulatory regimes is
a distant prospect, it should be embraced as an aspiration.
National and regional regulators are increasingly
corresponding with one another to ensure that their
regulatory schemes mesh and loopholes are closed. Most
recently, we have seen coordinated moves by London and
Paris regarding taxes on bonuses. Regulatory strategy
needs to be conceived and managed globally.
ƒƒ Become more sophisticated at interpreting and
implementing regulation. Often this work is left to the
compliance function, with top leaders giving little thought
to how new regulation will alter a business from end to
end, and perhaps diminish its attractiveness. The ability
to interpret and implement regulation in a way that both
puts the bank ahead of regulatory “best practice” (thereby
avoiding sometimes hefty fines) and allows the affected
businesses to continue—and make profits—looks more and
more like a significant competitive advantage.
Find growth opportunities. Before the crisis, many banking
growth strategies were similar and oriented toward the
expansion of lending despite its narrow margins. After the
crisis, growth will be harder to achieve for many US and
European banking groups, and gaining access to faster-
growing markets in Asia and elsewhere will be challenging.
For most banks in the developed world, a careful rebalancing
of businesses and the geographic footprint will be needed to
open new growth opportunities. Those banks that identify and
3 For more on micromarkets and defining pockets of growth, see “The Granularity of Growth” and “A fine-grained view of the sources of growth”
(Mehrdad Baghai, Sven Smit, and S. Patrick Viguerie), both at mckinseyquarterly.com.
4 Developed-market banks should also consider the opportunity in “rehabilitating” households with impaired credit, continued innovation and cost
reduction through technology and cheaper channels, and, where possible, growth opportunities in Asia.
12
invest in the fastest-growing micromarkets, while moderating
their pursuit of overbanked markets, will do better than those
that seek to compete across the board.3, 4
Banks in emerging markets must consider how best to
capitalize on the growth opportunities in their home markets
to build their institutional capabilities and strengths. That
said, the picture will vary enormously by institution. Growth
is sufficiently complex in the new world that we believe
banking executives must grapple with the question now, even
if it is only possible in 2011 and beyond.
Manage liquidity like the scarce resource that it is. During
the crisis, the treasurers of many banks were thrust into the
spotlight, shifting a typically technocratic and market-facing
role to one of the most strategic and high-profile jobs in
banking. Given the likely continued scarcity and cost of long-
term funding, treasurers will not return to obscurity anytime
soon. In fact, we believe banks with a good treasury strategy
and infrastructure will enjoy a strategic advantage over
others. Three best practices are essential.
First, banks should have a house view on both the long-term
shape of the balance sheet and the market’s supply of liquidity,
including a board-level understanding of the organization’s
appetite for the risks associated with maturity mismatch.
This includes a fully developed stress test of the bank’s
liquidity position. Second, they should have mechanisms to
track liquidity consistently and in near real time (based on
a set of highly specific key performance indicators applied
consistently to all parts of the bank) and to price internal
funds in ways that reward businesses for generating “sticky”
deposits. Finally, they need a group-wide funding and deposit
strategy. For some banks, this may necessitate organizational
changes: the institution of a deposit “Czar,” for example, or
a committee of business leaders able to rationalize cross-
divisional deposit projects and prevent different businesses
from going after the same deposit base.
Measure risks better to understand true returns. Given the
scarcity of businesses in the new world that will throw off
ROEs of 15 percent or more, approximate assessments of
Banking & Securities
The next normal: Banking after the crisis
business performance will no longer suffice. Large banking
groups must measure true returns after all allocated costs,
across all meaningful performance units, at least quarterly
and ideally monthly. The goal should be to reward individual
performance on a risk-adjusted basis, especially in the front
office and in businesses exposed to credit risk.
For many banks, the first hurdle here is to improve their risk
MIS (management information systems). In the crisis, banks
have been awash in the difficulties of creating or interpreting
risk MIS, and now there are whole new categories of data to be
managed (thousands of pages of new regulations containing
dozens of new metrics to record and report, compensation
data normalized for thousands of staff over long periods of
time and benchmarked to peers, and so on). The investment
will pay for itself in loss avoidance, and it will help get the
industry back on its front foot with regulators and provide the
tools needed to manage liquidity and allocate capital to the few
attractive opportunities in the market.
Manage the new set of stakeholders. In the next normal,
banks will need to be much better than in the past at
managing a more diverse set of global stakeholders. Banks
are accustomed to meeting the needs of shareholders and
employees. Now regulators, as discussed, have become a much
stronger and more integrated stakeholder. The government,
as the agency of the body politic, is deeply concerned with the
role of banks in the financial system. And a newly aggressive
press must also be reckoned with.
The industry would be in a better position today if it had been
more thoughtful about its relationships and messaging with
these stakeholders. Simply put, banks need to improve their
relationships with the outside world, not just recasting their
regulatory strategy but also adopting a much more considered
approach to shaping public opinion. Instead of relying on
spontaneous remarks from chief executives, banks should
try to get carefully worded messages in front of influential
decision makers and the general public. Banks need both to
improve their side of the story, by developing thoughtful ways
to recommit to societal improvement, and to tell that story in
ways that connect with these new and powerful stakeholders.
Divisional and business actions
Reevaluate business performance in the next normal.
Our model has shown variability in the performance of
geographies, business systems, and institutions in a banking
13
environment that is more regulated and less buoyed by benign
macroeconomic conditions. In this environment, businesses
must be much more transparent about their performance and
risks in order to deploy capital much more precisely and take
advantage of scarce opportunities as they develop. Banks need
to:
ƒƒ Rethink the business model of those businesses
most affected by the crisis. As regulators respond to
the crisis, banks must revisit all their major assumptions,
particularly those concerning margins and volume
growth. Many institutions do little more than roll forward
their old models, most of which should be fundamentally
revised or discarded.
ƒƒ Be prepared to act on their findings. The rapidly
changing and less profitable markets ahead will require
radical portfolio shifts for some institutions. Today, banks
rarely shift capital from one unit to another, but to preserve
profitability, they will need to learn. These reallocations
will go well beyond the ring-fencing of noncore assets (that
is, “bad banks”) that some have already set up. Making
these shifts requires far sharper “teeth” at the group
level, including decisive leadership and the setting of
appropriate expectations in strategy planning. Business
heads need to understand that “their” capital can be
withdrawn if targets are not met and the bank can identify
a more attractive opportunity.
Become (still more) efficient. Many of the actions
recommended so far involve some uncertainty, or at a
minimum are not entirely within the institution’s control.
Banks can influence but ultimately not change regulation,
pricing moves will trigger competitive responses, and
so on. Cost cutting, on the other hand, is squarely within
management’s control. If the extreme scenario materializes,
the institutions most challenged by weak returns will need
to pull many levers, cost among them. If they were to rely on
cost cutting alone to restore returns to a respectable level (15
percent ROE), some institutions would need to cut today’s cost
base by 25 percent, according to our analysis.
When asked, some industry leaders say that this level of cost
cutting is impossible. But in our experience, a comprehensive
cost-reduction program—from rigorous review and
management of noncompensation expenses to organizational
changes such as eliminating management layers to
operational improvements such as lean—can deliver savings

of that magnitude over three to five years. Indeed, companies
in industries such as high tech have reduced costs by similar
levels during times of strategic change.
Improve pricing. Many corporate and wholesale businesses
enjoyed profits in 2009 comparable to those in 2007. The main
driver of this strong performance was pricing: as competitors
exited the market and customers became newly appreciative
of banking capacity, banks widened their margins. For many
businesses, however, these increases were not sophisticated
or sustainable. Moreover, and unlike other industries, banks
have limited pricing capability. If our return forecasts are
directionally correct, however, clever pricing will be necessary
to elevate returns back to an acceptable level. Main levers
include fixing technical “leakages” (that is, errors embedded
in pricing IT systems) and commercial leakages (eliminating
unnecessary discounts); optimizing the price list (for example,
by reviewing pricing levels across the customer base); and
introducing innovative pricing schemes.
Compete for talent under stricter compensation rules. Banks
need to find ways to attract and retain top-notch talent in
an environment where the options for pay are much more
restricted. It is important to provide clear career perspectives
for top performers to avoid a greater exodus of key employees
to less regulated financial institutions. At the same time,
a bigger focus on risk-adjusted compensation can help
institutions attract the kind of talent that will perform well on
a risk-adjusted basis.
Organizational enablers to improve flexibility
Incorporate new scenario-building and stress-testing
capabilities into strategy development. Before the crisis,
few banks had the ability to model the impact of multiple
economic scenarios on group-wide finances. In response to
regulators’ frequent requests for scenarios during the crisis,
banks have built whole new scenario-planning functions.
Banks should put their new scenario-planning and stress-
testing capabilities to work. They can use these skills to ensure
the viability of their business model in a range of potential
future outcomes, and also to consider explicitly the optionality
and flexibility that many of them possess but do not always
use in their decision making.
Reinvent strategic planning as a dynamic activity. At many
large banks before the crisis, group-level strategic planning
14
was an annual and finance-driven event, with limited detail
provided by businesses and divisions. Top-down challenges
to divisional plans rarely went beyond the highest levels
(revenues, costs, profits). In the heat of the crisis, this
staged and staid exercise fell by the wayside. Banks had
to make major strategic decisions in response to markets,
shareholders, and governments very rapidly, making 2009 a
year of almost constant strategic revision. That leaves banks
with an opportunity. We believe that banks can reinvent
strategic planning to make the process less monolithic and
more flexible. They should:
ƒƒ Introduce more flexibility into the planning process
by defining dynamic plans with contingent budgets
depending on the evolution of scenarios and the
occurrence of trigger events.
ƒƒ Use a “portfolio of initiatives” approach to rationalize and
apportion investment in new projects.
ƒƒ Integrate strategy creation more tightly with risk
management. The planning process should begin with
a top-down, risk-appetite-led view of the target balance
sheet for the group. Balance-sheet usage should then be
allocated to divisions on the basis of both nominal and
risk-weighted assets.
ƒƒ “Stage gate” investments in key initiatives and make
critical strategic decisions on a “just-in-time” basis.
ƒƒ Reevaluate the “ownership” of strategic planning.
Typically, ownership lies somewhere between the finance
and strategy groups, with the risk group rarely involved
to any significant degree. One solution would be to move
planning entirely into strategy, ensuring that strategy
has the credibility within the organization to run a tight
process and push decisions with senior management.
Regardless of where strategic planning resides, the risk
team should be closely involved in the process from the
beginning.
Realign governance and leadership processes for senior
managers to improve decision making under uncertainty.
Given the work entailed in responding to the crisis,
employees in most banks show a sharply elevated level of
“change fatigue.” Regrettably, the uncertainty faced by most
institutions continues, as do the challenges that come with
Banking & Securities
The next normal: Banking after the crisis 15

it. Senior management needs to build a strong team of top
executives that can manage under uncertainty (including
being alive to the possibility of all kinds of change) while being
able to provide clear directions to the businesses they lead.
***
For most banks, 2010 will be another year of significant
uncertainty. As evidenced by the market’s reaction to the
recent Obama announcements, the forecast for banking
profitability can change overnight. In this environment, it
is understandably difficult to step out of the fray and draw
conclusions about the long term. But as a year in which major
regulatory change might get ironed out, impairments will
likely peak in many markets, and a wave of asset sales will
start to swell, 2010 is also a juncture at which the shift toward
a long-range perspective will prove critical. Indeed, it is the
ability of banking leadership to make this shift that could
ultimately be the biggest determinant of their institution’s
performance when the crisis subsides.

Acknowledgments
The authors thank colleagues Lowell Bryan, Christian Casal, Toos Daruvala, Przemek Pieta, Pedro Rodeia, and Charles
Roxburgh for their contributions to this paper.

Tab Bowers is a director in McKinsey’s Tokyo office, and Olivier Hamoir is a director in the Brussels office. Anna Marrs and Max
Neukirchen are principals in the London and New York offices, respectively.

Contact for distribution: Anna Marrs

Phone: +44 (20) 7961 5654
Email: Anna_Marrs@mckinsey.com
Banking & Securities
March 2010
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