Traditional investment banking model ‘no longer an option,’ states McKinsey & Company ‘blockchain technology could deliver a broad range of benefits’

Global management consulting firm, McKinsey & Company, recently published a report outlining strategies that could help the capital markets and investment banking (CMIB) industry. “Time for Tough Choices And Bold Actions” defines the industry’s ailments and proposes initiatives that banks could implement, including the adoption of blockchain technology.

“The inescapable reality is that the industry’s restructuring efforts to date have failed to produce sustainable performance. A more fundamental change is required, based on the realization that for most banks, the traditional model of global capital markets and investment banking is no longer an option.”
— – McKinsey & Company

Founded in 1926, McKinsey employs more than 10,000 business and management consultants, and nearly 2,000 research professionals today. The firm works with clients across 22 sectors and 12 business areas. With revenue of $8.4 billion, the firm was ranked 39th on Forbes’ America’s Largest Private Companies in 2016. According to career website, Vault.com, McKinsey has been top of the list as the Most Prestigious Consulting Firms every year, since the company started the ranking 14 years ago.

McKinsey explains that the CMIB industry continues to suffer from sustained weak profits and high costs resulting from low interest rates, heightened regulation, and economic uncertainty. Global CMIB revenues have remained “stubbornly flat,” since the financial crisis.

Banks have mainly responded to profit pressure with major cost-cutting and restructuring, “but these measures have failed to significantly improve performance,” the report reveals. While some banks performed well in 2015, McKinsey claims that 2016 has been more challenging. “For most of these big banks, the days of being a global universal player are gone.”

“CMIB clients are challenging the value added by banks today,” McKinsey explains. Instead of having one provider, “Clients are increasingly unbundling their decision making and selecting the best provider in each product and region.”

“Non-bank market makers are increasingly active in equities and, more recently, in Treasuries, FX and interest rate swaps market-making,” McKinsey claims. The firm’s report concludes by urging CMIB banks to “make tough choices and take bold actions now.”

“Banks should abandon hope of a cyclical upturn and focus on structural change.[…] Too many banks continue to wait for salvation from revenue growth based on traditional CMIB business models. After seven years of underperformance, the time for waiting is over.”
— – McKinsey

The findings echo Ernst & Young’s research on bank relevance. The firm found that traditional banks are becoming less relevant. Consumers preferences and expectations are rapidly changing. They are starting to stray towards easy-to-use FinTech products and bank alternatives.

McKinsey suggests fundamentally changing business models, including scaling back their CMIB operations. Banks need to reduce “their product set, client mix and regional footprint, accompanied by a commensurate change in their cost structure,” the report reads.

McKinsey also suggests making better use of FinTech, and participating in industry utilities. The firm conducted a survey of CMIB leaders in April, and found that 53 percent of the respondents’ institutions were already partnering to develop and customize FinTech solutions, while 32 percent were investing in FinTech startups.

New industry utilities on the other hand, are “poised to deliver economies of scale,” the firm claims. An industry utility is an entity created by a variety of industry participants to create efficiencies. While there are challenges in their adoption, McKinsey sees them as encouraging developments that could help the CMIB industry with both growth and cost reduction. “Participating in industry utilities, including distributed ledgers (blockchains),” is one of eight key initiatives suggested by the firm.

“In the coming years, blockchain technology could deliver a broad range of benefits—including faster clearing and settlement, ledger consolidation, consolidated audit trail, reduction in systemic risk and operational improvements—to firms across the capital markets industry, from clearing houses and exchanges to prime brokers and banks.”
— – McKinsey

According to global professional services company Accenture, Blockchain utilities can help smaller banks remain competitive by bundling activities across different players. “The post-financial crisis cost pressures have served to highlight the opportunities for utilities to reduce costs, achieve standardization of processes, mutualize future change and increase service quality in these core processing domains.”

Accenture states that blockchain technology solves two of financial transactions’ most fundamental challenges: reconciliation and auditability. In addition, it would optimize settlement, removing “a tremendous amount of friction from the current trading life cycle and unlock a vast amount of capital that is trapped in the settlement process,” the firm explains.

“Given the opportunity to reduce costs, lower counterparty risk, improve liquidity, optimize capital and streamline regulatory reporting, one thing is clear: investment banks will look to distributed ledger and blockchain technology as a way to alter the economics of their businesses and bring cost-income (C/I) and return on equity (ROE) ratios closer to pre-financial crisis levels.”
— – Accenture

However, integrating blockchain solutions into legacy bank infrastructure will not be simple. Accenture says that “multiple points of integration and further developments would be required to reach a production-ready state.”

Morgan Stanley states that “cost mutualization” is one of the key factors to implementing a blockchain financial system. The firm published a report in April titled “Blockchain in Banking: Disruptive Threat or Tool?” which explained that building blockchain-based financial system utilities will be costly but “mutualization” of the blockchain utilities between banks could boost earnings after multi-year investment. "Banks will need to share infrastructure build-out costs equitably if new systems are to be truly inter-operable industry utilities," the firm asserted.

According to McKinsey, post-trade costs, such as from settlement and reporting processes which generate significant IT and labor costs, could be reduced by more than 70 percent. “KYC and client onboarding are also ripe for the efficiencies that utilities can deliver,” the firm claims.

A study commissioned by DTCC in 2014, focused on the post-trade ecosystem in the U.S. and Europe, revealed that “industry utilities accounted for only 5% of the approximately $100 billion spent annually on back office costs.” Effectively leveraging industry utilities and collaborating would drive down costs and risks through economies of scale, according to Michael Bodson, DTCC President and CEO.