The Return of Return-on-Equity: Double-Digit Profits Are Possible, but Only with Fundamental Change

[ILLUSTRATION OMITTED] With pre-tax return on equity hovering at around 5% for banks nowadays, those lofty average returns of 26% they achieved only two years ago seem like a distant memory. While such spectacular performance may not be in the cards anytime soon, given low-growth expectations and a reshuffled market and regulatory environment, we believe an ROE of 15% by 2012 is eminently achievable for banks that fundamentally change the way they've been doing business. Among the most important changes: boosting capital efficiency; transforming credit quality; implementing proactive risk management; and achieving cost efficiencies across the enterprise. But the drive toward double-digit ROE will require leaders to undertake even more complex changes and make major strategic investments that go to the core of a bank's business proposition. Large retail banks will need to broadly rationalize their businesses. They must identify and implement new profit pools, innovate, and learn how to stave off new competition from trusted community banks and credit unions as well as foreign entrants, and perhaps even well-liked consumer brands, such as Wal-Mart or McDonalds. In the United Kingdom, for example, Tesco, one of the world's largest supermarket chains, is expanding rapidly into banking. Another emerging threat is low-cost online banking players like Ally Bank (GMAC's online bank) that can capture customers' deposits at a much lower cost than traditional providers. Most importantly, larger banks need to restore severely shaken customer confidence and embrace customer strategies that rely far less on traditional branch banking. And all banks will need to cast a wider net for potential customers through the online channel where, it is estimated, opening a new account costs pennies compared with over $50 to open one in person. To understand the scale of transformation that is required, Accenture conducted a survey this spring (www.accenture.com/ banking2012news) consisting of interviews with leaders of banks and private equity firms as well as equity analysts. We also analyzed and modelled the fundamentals of more than 150 banks, validating the results with clients. Our findings lead to the inescapable conclusion: from now on, only bold moves will do. Look for fewer banks Local and regional consolidation will result in significantly fewer banks of all sizes. In the U.S. for instance, the number of banks could conceivably be slashed from over 8,000 to 6,000 in just a few years due to inadequate capital to offset losses, lack of growth, and increased costs. Smaller and regional banks, particularly those with footprints in hard-hit economic areas and with high concentrations of commercial real-estate loans, are at the highest risk of failure. But for some select banks, consolidation represents a once-in-a-lifetime opportunity for prudent and cost-effective growth. Profitable well-capitalized U.S. banks and enterprising foreign institutions, including Canadian, Spanish, Brazilian, and Japanese banks, will seek opportunities to expand at bargain-basement prices--free of the costs and restrictions of TARP-type rescue terms and strengthened by government down-side protection. The financial crisis has also taken a toll on the ability of many banks to maintain their international footprints. Some surviving multi-regional universal banks will continue to do business globally, but there will be far fewer of them. A handful of players, like HSBC and Santander, will be able to operate with truly simplified global operating models providing differentiated opportunities for efficient revenue growth. Others will focus on becoming global specialists--in wealth management, consumer finance, transaction banking, and investment banking--or they will scale down to reinforce their regional dominance. One of the largest U.S. banks, for example, announced plans earlier this year to slim down by winding down its brokerage operations and concentrating on its stronger businesses. …

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