Local banks must reinvent themselves or risk becoming irrelevant

Approximately two-thirds of banks in Malaysia are finding it challenging to generate sufficient returns above the cost of equity


A MAJORITY of the local banking groups are struggling to generate returns above the cost of equity, forcing these lenders to reinvent themselves or risk becoming irrelevant.

According to McKinsey & Co senior partner Joydeep Sengupta and associate partner Ervin Ng, developing markets in Asia, including Malaysia, historically generated returns on average equity of approximately 15% to 20%.

But this has been converging towards the global averages of approximately 10% over the past several years, they said.

“Approximately two-thirds of banks in Malaysia are finding it challenging to generate sufficient returns above the cost of equity of approximately 10% to 11%,” they told The Malaysian Reserve (TMR). T hey said there are a number of headwinds affecting the banking landscape today, including macro-economic uncertainties, systemic industry challenges and disruption from digital attackers and digitising incumbents.

“These forces have been creating significant pressure for banks today in terms of margins and risk costs, among others, which are leading to a compression on both returns and valuations as indicated by price-to-book ratios,” they said.

“As we go deeper into this cycle, these challenges are expected to persist and it could mean that not all banks would be able to survive the storms ahead,” said the analysts.

Excluding development banks, there are 54 licensed financial institutions in Malaysia today, comprising 26 commercial banks, 17 Islamic banks (one of which is international) and 11 investment banks.

Two-thirds of this total represents close to 36 banks in Malaysia struggling to generate returns above the cost of equity — the compensation paid to shareholders in exchange for owing the asset and taking on the risk of ownership.

A check on Bloomberg revealed that BIMB Holdings Bhd was among the banking stocks with the highest return on common equity (ROCE) at 14.27% on June 30 this year.

ROCE refers to how much profit a company generates with the money shareholders have invested.

Malaysia’s largest banking group, Malayan Banking Bhd (Maybank), registered an ROCE of 10.61% for the same period, while Public Bank Bhd came in at 13.51%. CIMB Group Holdings Bhd, Hong Leong Bank Bhd, RHB Bank Bhd and AMMB Holdings Bhd registered returns of 9.67%, 10.79%, 10.09% and 8.84% respectively.

Banks such as Alliance Bank Malaysia Bhd and Affin Bank Bhd, meanwhile, had returns of 8.61% and 6.63%.

Sengupta and Ng said banks must move fast or risk succumbing to industry’s pressures and becoming irrelevant.

“The call to action for banks is to quickly move to strengthen their core in terms of productivity, risk and resiliency, and capital optimisation,” they said.

Banks will also need to capture “pockets of growth” in the emerging opportunities of wealth, retail and small and medium enterprise lending, and transaction banking — collectively representing an approximately US$100 billion (RM420 billion) revenue opportunity.

“Doing so requires the ability to deploy the new tools, technologies and capabilities of digital and analytics in a focused manner of execution.”

Sengupta and Ng said banks should view partnerships — both via organic and inorganic means — as a core pillar of their reinvention moving forward.

“Given the potential consolidation looming in the horizon ahead for banking, banks can consider looking at merger and acquisitions (M&As) in a programmatic way as a means to capture value from synergies,” they said.

In Malaysia, the banking sector’s latest efforts to consolidate via M&As have been muted.

Malaysia Building Society Bhd became a full-fledged Islamic bank after completing the RM645 million acquisition of Asian Finance Bank Bhd early in 2018, but the proposed merger between AMMB and RHB Bank reportedly fell through in 2017 due to valuation issues.

In September this year, Malaysian Industrial Development Finance Bhd and Al Rajhi Banking and Investment Corp (M) Bhd were reported to have submitted a merger proposal after securing repeated extensions to continue talks.

However, neither banking group has confirmed the veracity of this report.

Sengupta and Ng said banks should focus on the post-merger integration plan as the majority of value in an M&A endeavour depends on successfully executing the integration.

“Beyond this, banks should holistically look at partnerships as a means to improve their products, services, experiences and operations across the board.”