The state of retail banking: Profitability and growth in the era of digital and AI

The State of Retail Banking: Profitability and Growth in the Era of Digital and AI

Executive Summary

Retail banks around the globe have experienced a period of significant success, driven by several key factors. During the COVID-19 pandemic, government stimulus and increased consumer savings contributed to higher profitability. Rising interest rates in 2022 further enhanced net interest margins, leading to record-high returns on equity (ROEs) of approximately 12%, the highest since the 2008 financial crisis.

However, retail banks now face several challenges:

1. Cost Inflation: Higher operational costs.
2. Increased Fraud: More sophisticated and frequent fraudulent activities.
3. Uncertainty in Interest Rates: Volatility in interest rate forecasts.

These factors are expected to limit asset growth, compress margins, and increase costs for banks. Additionally, rising consumer expectations and a competitive fintech sector are adding to the pressure.

To counter these challenges, banks are focusing on two main strategies:

1. Deepening Primary Relationships: Building strong, long-lasting customer relationships.
2. Protecting Margins: Utilizing advanced technologies like digitization, AI, and generative AI to enhance efficiency and reduce costs.

Banks are also investing heavily in technology, with a particular emphasis on AI and generative AI to develop next-generation deposit capabilities. They aim to protect margins through targeted investments in these technologies to improve pricing, mitigate losses, and increase productivity.

Key Data and Trends

1. Return on Equity (ROE):

   • Global banking ROEs reached 12% in 2023, the highest since the 2008 financial crisis.
   • Latin America, the Middle East and Africa, and Emerging Asia (excluding China) led with up to 17% ROE, followed by North America at 10% and Developed Asia, China, and Europe at up to 9%.

2. Revenue Growth:

   • The global retail banking market surpassed the $3 trillion revenue mark, with sustained annual growth of about 8%.
   • Europe, Developed Asia, Emerging Asia (excluding China), Latin America, and the Middle East and Africa showed significant acceleration in revenue growth, driven by higher interest rates and increasing financial inclusion.

3. Deposit Growth:

   • Deposit growth significantly slowed in high-interest-rate environments.
   • North America and other regions saw declining or decelerating deposit growth as governments tightened monetary and fiscal policies.

4. Interest Rate Environment:

   • The current environment features positive real interest rates and quantitative tightening, which is expected to continue.
   • Central banks are likely to limit or even reduce the growth of their balance sheets in response to these trends.

Conclusion

The retail banking sector is entering a new phase characterized by both opportunities and challenges. Banks need to adapt quickly to maintain profitability and growth. By leveraging advanced technologies and strengthening customer relationships, leading institutions can navigate the changing landscape effectively.