Global management consulting giant McKinsey: Traditional investment banking model is 'no longer an option', blockchain can provide various benefits

McKinsey & Company, a global management consulting firm, recently released a report outlining a number of strategies that could help the capital markets and investment banking (CMIB) industry. The report, titled ‘Time for Tough Choices And Bold Actions’, identifies the ills of the industry and suggests initiatives that banks can implement, including adopting blockchain technology.

“The inescapable reality is that the industry’s restructuring efforts have so far failed to produce sustainable results. A fundamental change is needed, based on the reality that the traditional model of global capital markets and investment banking is no longer an option for most banks. – McKinsey”

Founded in 1926, McKinsey now employs more than 10,000 business and management consultants and nearly 2,000 researchers. The firm's clients come from 22 sectors and 12 business regions. With annual revenues of $8.4 billion, it ranked 39th on Forbes' list of 'America's Largest Private Companies' in 2016. According to the career website Vault.com's ranking for 14 years, McKinsey has been among the most prestigious consulting firms every year.

McKinsey believes that the CMIB industry continues to suffer from persistently weak profits and high costs due to low interest rates, increased regulation and economic uncertainty. Since the financial crisis, global CMIB revenues have been in a "stubborn slump".

Banks have been responding to profit pressures due to major cost-cutting and restructuring, the report said, 'but these measures have failed to significantly improve performance.' While some banks performed well in 2015, McKinsey claimed that 2016 was more challenging. "For most of these large banks, the days of being a global player are over."

McKinsey explains:

“CMIB clients are now challenging banks to add value and instead of having just one provider, clients are increasingly factoring their pricing decisions and choosing the best provider in each product and region.”

McKinsey states:

“Non-bank market makers have become increasingly active in equities, and more recently, in the U.S. Treasury, foreign exchange, and interest rate swap markets.”

The company's report concludes by calling on CMIB banks to "make tough choices and take bold actions."

“Banks should abandon hopes for a cyclical recovery and focus on structural change. Too many banks are still waiting for salvation from revenue growth based on the traditional CMIB business model. After seven years of underperformance, the wait is over. - McKinsey”

The findings are consistent with those of EY's banking research, which found that traditional banks are becoming increasingly irrelevant. Consumer preferences and expectations are changing rapidly. They are turning to easy-to-use financial technology products and banking alternatives.

McKinsey recommends fundamental changes to business models, including scaling back their CMIB operations. Banks need to reduce “their product set, customer mix and regional footprint, accompanied by commensurate changes in their cost structure.”

McKinsey also recommends taking advantage of financial technology and participating in industry utilities. The firm surveyed CMIB leaders in April and found that 53% of respondents' institutions are already collaborating to develop and customize financial technology solutions, while 32% are investing in financial technology startups.

On the other hand, new industry facilities are prepared for the expansion of economies of scale, the firm said. Industry utilities are entities created by various industry participants to create efficiencies. Despite challenges in adoption, McKinsey believes that these encouraging developments can help the CMIB industry grow and reduce costs. "Participation in industry utilities, including distributed ledgers (blockchain)" is one of the eight key initiatives recommended by the firm.

“In the coming years, blockchain technology could offer a wide range of benefits — including faster clearing and settlement, ledger consolidation, unified audit trails, reduced systemic risk and improved operations — to a wide range of firms in the capital markets industry, from clearing houses and exchanges to major brokerage firms and banks.”

According to global professional consulting services company Accenture, blockchain utilities could help smaller banks remain competitive by bundling the activities of different players.

“Post-financial crisis cost pressures highlight opportunities for utilities to reduce costs, standardize processes, share future changes, and improve service quality in these core processing areas. – Accenture”

Accenture believes that blockchain technology solves two of the most fundamental challenges of financial transactions: reconciliation and auditability. In addition, this technology will optimize settlement, removing "huge friction from the current transaction life cycle and freeing up large amounts of capital trapped in the settlement process."

However, integrating blockchain solutions into traditional banking infrastructure is not simple. Accenture said that multiple integration points and further development will be required to reach production readiness.

Morgan Stanley points to “cost mutualization” as a key factor in implementing blockchain-based financial systems. The company published a report in April titled “Blockchain in Banking: Disruptive Threat or Tool?” explaining that creating blockchain-based financial system utilities will be costly, but that ‘mutualization’ of blockchain utilities between banks could improve profitability after years of investment. The company claims that “if the new system is to be a truly interoperable industrial utility, banks need to collectively and reasonably bear the cost of building the infrastructure.”

According to a McKinsey report, post-trade costs, such as the settlement and reporting process, which incurs significant information and labor costs, could be reduced by more than 70%. The firm states:

“KYC and customer base are also ripe for the efficiencies that public facilities can provide.”

A 2014 DTCC research report focused on the trade ecosystem in the United States and Europe. According to DTCC President and CEO Michael Bodson,

'Industry utilities account for only 5% of the nearly $100 billion spent on back-office operations each year. Effective use of industry utilities and collaboration will reduce costs and risks through scale.'