Breaking up is hard to do

Have you ever said something bold and then a really smart person somewhere else says the same thing? For some time now I have been saying that Too Big to Fail Banks will lose out to fintech.

I have argued that the giants are too big to care, pocketing rising interest rates and neglecting startups and small businesses, the backbone of the American economy; and that banks cannot or will not adopt new technology because they are too entrenched in older offline processes, a relationship-driven approach built over a century with a small group of similarly sized companies.

Startups want the opposite: a seamless, digital and personalized experience with the same high-end and high-performance services that banks reserve for their biggest corporate customers. The same dynamic allowed fintechs to win the credit card market for startup and small business customers over the past 5 years. History is now repeating itself for banks across treasury, lending and expense management.

Now comes a new whitepaper from McKinsey & Co., “The Future of Banks: A $20 Billion Breakup Opportunity.” It takes a sobering view of the banking industry and calls for a “terrifying reorganization, or dissolution” of the Too Big to Fail banks if they are to withstand new challenges from fintech and Big Tech.

The McKinsey paper argues that “economic forces and technology have ended the run of the universal banking model.” It identifies five areas where banks need to completely transform: day-to-day banking, investment advice, complex financing, mass wholesale intermediation for corporate customers and Banking as a Service (BaaS).

Reality check: the chances are small that large banks will be able to transform themselves in one of these five areas, much less all five. The giants have proven unable to embrace new technology and deliver an app-based, customer-centric experience, and they’ve had 20 years to figure it out.

Breakup is right: Breaking themselves up may be their best chance for survival. Some of the biggest break-ups came at the behest of the companies themselves rather than public trustbusters. The old AT&T split into computers, long distance and equipment manufacturing in the 1990s, and now General Electric has split into separate firms for health care, aviation and renewable energy.

But the big banks? You will not see any of them doing this voluntarily.

The breakout article was published in the December McKinsey Quarterly, written by four partners on three continents: It rattles off a litany of industrial ills. Example: “Key measures for the banks are at a historic low. The sector’s price-to-book value has fallen to less than a third of the value of other industries. … margins are shrinking – down more than 25% in the last 15 years.” They are likely to continue to fall over the next decade.

Jamie Dimon of JP Morgan Chase also worries about the banks’ decline, as I wrote in a previous column. The banks’ share of mortgages plummeted from 91% over a decade ago, to just 32% now; their share of the loan market is down to just 13%, from 46% over 20 years.

The McKinsey partners note that other businesses, pound for pound, are now valued at more than three times the value of banks. “This means global investors are voting trillions of dollars against the future profitability and sustainability of the existing business model of universal banks,” they write.

They always say follow the money, and the money is flowing away from Too Big to Fail banks to Small Enough to Innovate fintechs. McKinsey & Co. counts 274 fintech unicorns, up from 25 in 2017, with a combined value topping $1 trillion.

Between the lines, the McKinsey paper is a jolt of fear aimed at persuading banks to hire the firm to help them innovate (I know a sales pitch when I see one, having started my career at the Boston Consulting Group, an arch-rival of McKinsey & Co. .).

The flaw with this is that the best innovation comes from outside, rather than from within, large and complacent incumbents who are focused on protecting their legacy businesses. Therein lies the innovator’s dilemma, as Harvard’s Clayton Christensen put it in 1997, and it rings true today.

The banking industry now manages $370 trillion in worldwide assets, and McKinsey estimates that this could grow to half a trillion dollars within a decade. But the real advances in serving startups and small businesses will come from innovators, outside the establishment, who leverage AI, Big Data and powerful, easy-to-use apps to take share from the big banks.