The biggest Wall Street banks have not done nearly enough to boost shareholder returns, despite years of cost-cutting and tailoring balance sheets to a more profitable mix, consulting firm McKinsey & Co said in a report released on Wednesday.
If those banks do not take more dramatic steps to reshape their business models, the industry's return on equity could fall further - to a mere 4 percent by 2019 from 8 percent last year, the report said.
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Those figures are far short of the 12 percent return on equity banks need to meet their cost of capital, said McKinsey, which works with big Wall Street firms on business strategy.
"Banks need to decide where they're advantaged to compete, and focus on the right products, the right geographies, the right clients that they're best positioned to serve," Kevin Buehler, co-leader of McKinsey's global risk practice, said in an interview. "Very few banks will continue to provide all products to all clients everywhere, as many aspired to do in the past."
For the past few years, Wall Street banks have been engaged in a staring contest, betting they can outlast competitors in unprofitable businesses. Returns will sail higher, the thinking goes, once rivals exit, because patient victors can gain market share and increase pricing with less competition.
While banks have been waiting for others to blink first, profits have come under increasing pressure from new regulations and weak volumes. In response, banks have slashed $10 billion from expenses and reduced risk-weighted assets by $1 trillion, said Buehler.
Banks will have to cut costs by another 25 percent - equating to $2.5 billion per firm, on average - while also boosting revenue by about $1 billion each, to get profit margins higher, he said. They will have to reduce risk-weighted assets by another 15 percent, or $60 billion per firm, on average, to boost returns to at least 12 percent, he said.
To achieve these goals, banks will have to make tough choices about what products and services to continue offering, Buehler said. They will also need to raise prices and outsource duplicative functions to industry "utilities" that can perform industry-wide tasks at a lower cost.
"Some real fundamental changes are necessary, and I do think it's partly a cultural change," said Buehler. "Capital markets and investment banking has to change from a cottage industry - where every bank does everything for everyone - to a much more lean and focused, industrialized one."