The financial services industry will significantly change in size and scope over the first two decades of this century, according to “Future of Financial Services – Future Scenarios,” published by Mercer Oliver Wyman.
The publication predicts that industry revenues will treble to $6 trillion, representing roughly 10% of global GDP in 2020 compared with 6% today, and that that there will be a far more complex pattern of value migration, from firm to firm, from sector to sector, and from traditional players to new entrants.
According to the publication, retail banking will grow faster than wholesale banking or insurance, with untapped value in specialist retail segments such as the credit-impaired or advice-seeking customers being captured. As a result, value from the ‘average consumer’ segment may become marginalized as customers demand and receive highly differentiated offerings.
Some financial services (FS) activities will shift to non-FS providers, both through the outsourcing and offshoring of back- and middle-office functions, and through ‘leakage’ to other industries, with major retailers, manufacturers and utilities leveraging their customer franchises and distribution skills to enter enduringly attractive FS markets. The recent shift of value from manufacturing to distribution will be accelerated as increasingly technology and customisation enable product innovation at the point of advice and sale to end customers.
Nader Farahati, managing director at Mercer Oliver Wyman, said, “The FS industry will not simply be a scaled-up version of today, but will take on a new shape. The cumulative effect of the way value is migrating within financial services will result in significant changes in the baseline size and shape of the industry, including shifts not only in revenue, but also in value and capital. The last few years are just the beginning: financial institutions need to draw lessons from the dramatic value shifts in other industries – to see who becomes the Walmart or Microsoft of the financial services industry in 2020.”
North America and Western Europe will see revenues increase by around 5.5 % per year, but other regions will see higher relative growth, with the “BRICs” (Brazil, Russia, India and China) growing more than twice as fast as the rest of the world. China’s financial services market will be comparable with Italy’s by 2010, and overtake Germany’s by 2020. Efficiency improvements and capital surplus will drive consolidation: Mercer Oliver Wyman forecasts that in 2020 the top 100 providers will supply 85 % of the market (compared with 65 % in 2002), with more cross-border financial services acquisitions over the coming years than is generally anticipated. In fact, a typical top 10 financial services provider in 2020 will have revenues of around $120 billion compared to $30 billion today.
Factors such as growth in global output and technological progress will tend to increase FS revenues, profits and total value. Other factors, including margin compression, self-insurance and escalating costs, will tend to do the opposite. Beyond these drivers, continued earnings growth and advances in capital management will generate significant surplus capital, which will also erode margins and encourage consolidation.
Mercer Oliver Wyman’s baseline forecast, showing economic profit of $1.6 trillion in 2020, is based on modelling which calculates country and product level growth, derived by measuring FS growth patterns to date, but also incorporating the influence of underlying external factors (e.g. demographic shifts, pension dilemmas and demand ‘enablers’ such as education and healthcare) and internal industry factors (e.g. industry regulation, consolidation and the evolution of supply chains).
In addition to the baseline forecast, the publication also assesses extremes of best- and worst-case outcomes. An optimistic scenario – of good external market growth conditions and the enlightened actions of suppliers – could see this growth up 40% to $1.9 trillion in 2020. Conversely, long-term harsh market conditions and a regressive reaction of suppliers might see industry economic profit in 2020 as low as $1.0 trillion.
However, different sectors are more or less susceptible to extreme scenarios such as the “optimistic” view would see economic profit in retail and wholesale banking increase 70% above the baseline forecast.
That said, such sectors that benefit from wealth creation are also likely to suffer most under negative external conditions. The “pessimistic” extreme would see EP in retail banking and insurance markets fall 40% below the core forecast.
In addition, for some sectors the internal and external factors have a widely differing importance. In wholesale banking efficient capital allocation and risk management can have a powerful impact and the sector has more scope than others to insulate itself in poorer economic conditions.
Investment banking – perhaps counter-intuitively – will be even less sensitive to external influences, as it is more “people-based” and can reinvent itself more easily, often profiting from market volatility.
Interest rates could also affect the baseline forecast, as the falling rate environment and low inflation have ‘underwritten’ much of the growth in Financial Services. To the extent that the next 15 years sees a higher rate environment, combined with commodity inflation, overcapacity and deflation in manufactured goods, this could lead to increased credit losses in higher-geared companies. This would also result in reduced discretionary income, and continued pressure on margins and on the viability of manufacturing activities in developed countries. In combination, these would also increase the volatility of capital flows and securities valuation.
In a context where each provider is effectively a combination of growing and maturing businesses, Mercer Oliver Wyman argues that for individual firms, the recipe for success is likely to have three elements: placing table stakes in growth markets, managing for value growth in maturing businesses, and dynamically hedging against potential negative market developments
Charles Bralver, Executive Director at Mercer Oliver Wyman, said, “Our projections identify major challenges for all involved in financial services. Providers have the greatest potential role in ensuring future FS growth: Their governance structures must be strong enough to avoid a re-regulation scenario. They must raise their game, especially in developing a flexible culture, which drives focus on value maximization using a range of approaches from appropriate M&A to demand innovation. Regulators, in turn, must aim for ‘just right’ regulation by carefully weighing the cost-benefit of any changes. Finally, customers must think more fundamentally about the nature of advice versus execution and demand customized levels of service and price to fit their own circumstances.”