Capital markets’ message to financial institutions: Differentiate or perish

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When COVID-19 first surfaced in early 2020, the economic impact and potential risks to the global financial system were highly uncertain. Sixteen months in, after unprecedented simultaneous stimulus programs implemented by governments across the world, the financial system is stable. The pandemic is far from over; case counts and deaths continue to surge in some parts of the world, but in others, the worst of the crisis has passed. For banks and other financial institutions, the focus is now shifting to the pandemic’s effects on their business models.

To understand how those effects have influenced the value of the world’s leading financial institutions and what those shifts may mean for the sector’s future, we analyzed capital-markets performance of the 599 diversified global financial institutions in our database. We found that 56 players each gained at least $5 billion in market cap in the past 16 months, adding about $1.3 trillion in combined market value (Exhibit 1).1 Another 28 institutions each lost more than $5 billion in value. The vast majority of our sample, however, saw relatively little change, neither losing nor gaining much market value.

The top players in financial services made significant gains during the past  16 months, adding about $1.3 trillion in market capitalization.

The massive gains made by the sector’s top performers, which account for less than 11 percent of the institutions in our sample, brought their share of the sector’s total market capitalization from 36 percent to an impressive 44 percent. As in other industries, the outperformers in financial services are pulling further ahead of the pack. Our analysis also suggests that investors are rewarding two models in particular: specialists and universal banks with strong domestic franchises and differentiated digital offerings.

The rise of financial specialists

Thirty-two of the 56 institutions that have gained the most value over the past 16 months have specialized business models focusing primarily on payments, financial market infrastructure, or investment banking (Exhibit 2). Collectively, specialists account for more than 70 percent of the $1.3 trillion in market cap added by the outperformers.

Nonbank specialists in financial services accounted for more than 70 percent of about $1.3 trillion in market capitalization.

In the payments category, a variety of digital players—including platforms, card networks, processors, vertical specialists, and “buy-now, pay-later” companies—made the biggest gains, reaping the benefits of generally capital-light business models combined with soaring demand for digital payments during the pandemic. One leading platform player, for example, saw growth of its payment volumes more than double, from roughly 20 percent in the first quarter of 2020 to more than 45 percent in the same period in 2021. This single company represented more than 10 percent of the sector’s total value creation during the time frame we studied.

Some market-infrastructure providers such as financial exchanges also created disproportionate value for shareholders, thanks in part to stellar sales growth. One exchange grew its revenues by 46 percent in one year by significantly increasing average daily turnover and benefiting from strong momentum in the IPO market. Investors are also embracing infrastructure firms that have pushed into adjacent businesses, such as data and technology services, to diversify revenues and those that added new products.

Additionally, record deal volumes in recent months have raised the market values of several specialist investment banks in developed countries. A few specialist securities houses with differentiated business models in emerging economies surged ahead as well. For example, investors have flocked to a Brazilian investment bank and wealth manager after it dramatically grew its wealth assets under management last year.

Champions among universal banks

A second trend our analysis highlights is the emergence of an elite group of universal banks amid generally flat or declining performance among such institutions. Of the more than 420 banks in our database that provide comprehensive financial services, only 24 added value of more than $5 billion in the past 16 months. Most of these outperformers are based in emerging markets, including four banks in the Middle East, three each in China and India, and one each in Brazil, Russia, and Singapore.

Most of the big value gainers among universal banks are domestic leaders that are making significant investments in digital capabilities as a point of competitive differentiation. In a few instances, investors rewarded banks for boldly reshaping their portfolios. One US bank, for example, has completed more than 30 digital acquisitions so far in 2021 as part of a clear strategy to diversify sources of revenue beyond traditional banking services. This and other banks have used M&A to pursue consolidation to drive scale, to gain footholds outside their home markets, or to expand their business portfolios aggressively to diversify revenue streams.

Incumbent financial institutions are likely to face challenging times ahead, including potential losses in their credit portfolios as the pandemic’s impact on businesses and consumers continues to reverberate. As players shape their strategies for the postpandemic world, they should reflect deeply on the signals that investors are sending. Is the current universal banking model becoming obsolete? Does the future require significant horizontal expansion into new areas beyond traditional banking? Is a major consolidation in domestic banking markets inevitable? Our flagship Global Banking Annual Review will examine these and other questions in the coming months.

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