Build a franchise in fast-growing and high profitability cities and countries, and you would almost automatically win. During the 1990s and 2000s, a large proportion of the variance in price/book ratio (P/B) among banks was driven by the ability of leading banks to reach growth hotspots ahead of the competition. Even the crisis didn’t alter the importance of portfolio strategy. In 2010, 74 percent of the difference in valuations between banks was explained by their performance in home markets. Accordingly, banks’ strategies were largely focused on the geographic portfolio. The big strategic choices of US, British, Dutch, French, Spanish, and US banks to move into fast-growing markets in Asia, Eastern Europe, and Latin America were the big stories in banking during that period.
Over the past few years this trend has markedly changed. Home market performance is still highly varied, but today it only explains a third of the difference in P/B among banks. We increasingly see high-performing banks in slow-growth markets, and the reverse. Notably, it is now not the location but the business model that matters more, especially the management approach and digital capabilities.
What’s driving the change?
First, we see a convergence between markets’ performance. For instance, emerging-market valuations have often been at least twice as high as in the developed world: 3.2 versus 1.6 in 2007, and 1.9 versus 0.9 in 2010. Today, P/B for both kinds of markets has fallen, to 0.96 for emerging and 0.91 for developed markets. Increasing geopolitical risk and macroeconomic slowdown in emerging markets such as China, together with the recovery of certain developed markets like those in North America, largely explain this convergence.
Second, we see a growing range of performance within most markets, as a new set of attackers and champions emerges. In many cases, digital banks have entered the market with valuation premium. Further, leading incumbents have introduced new strategies, such as the agile organization, digitizing end-to-end processes, and new digital brands and business models. Finally, investors are also becoming quite conscious of the long-term difficulty that many banks will have in sustaining their profitability. In more and more markets, digital leaders are valued twice as high, or more, as traditional banks.
Differences among markets
As the chart shows, in the top 10 banking markets by revenues, many value-creating banks (those whose P/B is greater than one) can be found everywhere, in developing markets such as Brazil, China, and India, and also in Canada, the United States and Western Europe. That’s a big change: for example, in 2010 Brazil’s banking sector had a P/B three times higher than the United States. In most of these geographies, innovators are thriving amid chaos. Banks that select the right business model, digitize their customer journeys, and target new generations effectively are creating more value than they did before.
Most notably, many banks in Asia continue to trade at a P/B of three or even four, because the high growth rates in their markets are still attractive. In India, small private banks that have a strong customer-centric focus and digital strengths are valued at a significant premium over traditional universal public-sector banks with much stronger branch networks.
If we look at the 50 banks that most outperformed their core market, half come from the United States, and the other half mostly from emerging markets such as Asia or the Middle East. Understanding and adopting the winning formulas (such as simplification and cost efficiency for US banks, or digital leapfrogging in the developing countries) has become a clear success factor to attract new investors in the digital era.
Of course banks should not draw the implication that portfolio strategy does not matter anymore. It is still essential to ride the wave of economic and banking-growth cycles. But the simple entry strategies banks have used in the past should be amended with a careful investigation into the right business model for the chosen geography, and into the best ways to adopt global value-creation best practices. Even more important, banks in their home markets can truly move the needle by reimagining their business model, digitizing their current footprint, and finding innovative ways to play in the newly emerging digital ecosystem.Detailed views on the economics of banking are available by request from McKinsey Panorama Global Banking Pools. Should you want more details or have any questions, Panorama’s Helpdesk (panorama@McKinsey.com) is happy to provide methodological and analytical assistance.