Traditional investment banking model 'no longer an option,' states McKinsey & Company ‘blockchain technology could deliver a broad range of benefits’

Luke Parker, 18 Sep 2016 - Banking, Blockchain Adoption, Mckinsey & Company   

Global management consulting firm, McKinsey & Company, recently published a report  outlining strategies that could help the capital markets and investment  banking (CMIB) industry. “Time for Tough Choices And Bold Actions”  defines the industry’s ailments and proposes initiatives that banks  could implement, including the adoption of blockchain technology.

Founded in 1926, McKinsey employs more than 10,000 business  and management consultants, and nearly 2,000 research professionals  today. The firm works with clients across 22 sectors and 12 business  areas. With revenue of $8.4 billion, the firm was ranked 39th on Forbes’ America's Largest Private Companies in 2016. According to career website, Vault.com,  McKinsey has been top of the list as the Most Prestigious Consulting  Firms every year, since the company started the ranking 14 years ago.

McKinsey explains that the CMIB industry continues to  suffer from sustained weak profits and high costs resulting from low  interest rates, heightened regulation, and economic uncertainty. Global  CMIB revenues have remained “stubbornly flat,” since the financial  crisis. 

Banks have mainly responded to profit pressure with major  cost-cutting and restructuring, “but these measures have failed to  significantly improve performance,” the report reveals. While some banks  performed well in 2015, McKinsey claims that 2016 has been more  challenging. “For most of these big banks, the days of being a global  universal player are gone.

” “CMIB clients are challenging the value added by banks  today,” McKinsey explains. Instead of having one provider, “Clients are  increasingly unbundling their decision making and selecting the best  provider in each product and region.

” “Non-bank market makers are increasingly active in equities  and, more recently, in Treasuries, FX and interest rate swaps  market-making,” McKinsey claims. The firm’s report concludes by urging  CMIB banks to “make tough choices and take bold actions now.” 

The findings echoe Ernst & Young's research on bank relevance.  The firm found that traditional banks are becoming less relevant.  Consumers preferences and expectations are rapidly changing. They are  starting to stray towards easy-to-use FinTech products and bank  alternatives. 

McKinsey suggests fundamentally changing business models, including  scaling back their CMIB operations. Banks need to reduce “their product  set, client mix and regional footprint, accompanied by a commensurate  change in their cost structure,” the report reads.

McKinsey also suggests making better use of FinTech, and participating  in industry utilities. The firm conducted a survey of CMIB leaders in  April, and found that 53 percent of the respondents' institutions were  already partnering to develop and customize FinTech solutions, while 32  percent were investing in FinTech startups.

New industry utilities on the other hand, are “poised to deliver  economies of scale,” the firm claims. An industry utility is an entity  created by a variety of industry participants to create efficiencies.  While there are challenges in their adoption, McKinsey sees them as  encouraging developments that could help the CMIB industry with both  growth and cost reduction. “Participating in industry utilities,  including distributed ledgers (blockchains),” is one of eight key  initiatives suggested by the firm.

According to global professional services company Accenture,  Blockchain utilities can help smaller banks remain competitive by  bundling activities across different players. “The post-financial crisis  cost pressures have served to highlight the opportunities for utilities  to reduce costs, achieve standardization of processes, mutualize future  change and increase service quality in these core processing domains.” 

Accenture states that blockchain technology solves two of  financial transactions' most fundamental challenges: reconciliation and  auditability. In addition, it would optimize settlement, removing “a  tremendous amount of friction from the current trading lifecycle and  unlock a vast amount of capital that is trapped in the settlement  process,” the firm explains. 

However, integrating blockchain solutions into legacy bank  infrastructure will not be simple. Accenture says that “multiple points  of integration and further developments would be required to reach a  production-ready state.” 

Morgan Stanley states that “cost mutualization” is one of the key  factors to implementing a blockchain financial system. The firm  published a report in April titled “Blockchain in Banking: Disruptive  Threat or Tool?” which explained that building blockchain-based  financial system utilities will be costly but “mutualization” of the  blockchain utilities between banks could boost earnings after multi-year  investment. "Banks will need to share infrastructure build-out costs  equitably if new systems are to be truly inter-operable industry  utilities," the firm asserted. 

According to McKinsey, post-trade costs, such as from settlement and  reporting processes which generate significant IT and labor costs, could  be reduced by more than 70 percent. “KYC and client onboarding are also  ripe for the efficiencies that utilities can deliver,” the firm claims. 

A study  commissioned by DTCC in 2014, focused on the post-trade ecosystem in  the U.S. and Europe, revealed that “industry utilities accounted for  only 5% of the approximately $100 billion spent annually on back office  costs.” Effectively leveraging industry utilities and collaborating  would drive down costs and risks through economies of scale, according  to Michael Bodson, DTCC President and CEO.

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