The global banking industry has experienced its most profitable period since 2007, but despite this success, structural and macroeconomic shifts demand that banks evolve. McKinsey senior partner Alex Edlich and partner Reinhard Höll, speaking on The McKinsey Podcast, discuss insights from McKinsey’s Global Banking Annual Review and the key challenges banks face.
A Time of Transition
The banking sector is undergoing a fundamental shift. According to Edlich, $402 trillion in global financial assets exist, yet over half are now outside traditional bank balance sheets. Instead, they have flowed into mutual funds, insurance companies, pension funds, sovereign wealth funds, and private capital.
While bank balance sheets are shrinking, rising interest rates have driven profits, boosting the sector by approximately $280 billion in 2022. Additionally, the rapid rise of generative AI is transforming banking operations. Unlike past large-scale technology projects, AI solutions today can be deployed swiftly and efficiently.
Challenges Facing Banks
Traditional banks are losing ground to payment specialists and embedded finance solutions, with consumer digital-payment processing growing over 50% in recent years. Mobile and digital-first banking models are becoming the norm, forcing banks to rethink their distribution strategies.
Höll highlights that up to 30% of retail banking distribution may soon happen through third parties, such as online comparison platforms and fintech partnerships. This requires banks to reconsider their positioning—whether to compete directly, provide services at scale, or find alternative revenue models.
Emerging Risks
Banks must also navigate heightened risks, including interest rate fluctuations, regulatory changes, and increasing cyber threats. Höll notes that as banks integrate with external platforms through APIs, they face added vulnerabilities from their partners’ compliance practices.
To mitigate risk, banks should focus on real-time fraud detection, holistic risk management, and fostering a strong risk culture. According to Höll, institutions with a robust risk culture are better equipped to navigate uncertainty.
A Global Perspective
Geographically, the shift of financial assets away from bank balance sheets varies. North America and Europe have seen approximately 77-79% of new financial assets move outside traditional banking, while in China, the figure is lower at 34%. The Indo-Crescent region—spanning East Africa, the Middle East, India, ASEAN, and Australia—now hosts many of the world’s top-performing banks.
This region’s rise is fueled by an expanding middle class, growing cross-border payments, SME financing in ASEAN, and wealth management in the Middle East. Banks in these markets are capitalizing on digital transformation and economic growth.
Technology as a Competitive Edge
To remain competitive, banks must prioritize AI and digital innovation. Edlich emphasizes that banks can enhance productivity, improve customer service, and develop innovative financial products through AI and advanced analytics.
Leading banks in Europe, for instance, invest 2.5 times more in technology than their lower-performing counterparts. AI-driven solutions, such as intelligent customer interactions and fraud detection, provide rapid returns, often within months. However, as Höll notes, successful adoption requires both investment and organizational alignment.
Scaling or Exiting Businesses
As part of their transition, banks must determine whether to scale up or exit certain businesses. Höll explains that smaller banks may need to partner with larger institutions to remain competitive in areas like securities services and capital markets. Conversely, some banks may need to consolidate or divest underperforming segments.
Rethinking the Balance Sheet
With 70% of financial stock growth occurring off bank balance sheets, institutions must strategically decide which assets to hold versus syndicate or distribute. Edlich advises that banks should assess which clients, products, and markets align with their core balance-sheet capabilities while leveraging alternative funding sources.
The Road Ahead
While banking remains a business of managing risk, institutions must balance technological advancement, regulatory compliance, and evolving consumer expectations. As banks navigate this period of transformation, those that adapt to digital disruption, rethink distribution, and optimize risk management will be best positioned for long-term success.
This article is based on insights from The McKinsey Podcast and McKinsey’s Global Banking Annual Review. Click to read more: https://www.mckinsey.com/industries/financial-services/our-insights/the-changing-landscape-for-banks
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