The globe struggled to deal with the COVID-19 pandemic's aftermath and its economic and social repercussions in 2022, which presented the global banking sector with several previously unheard-of difficulties and uncertainties. Additionally, banks had to deal with a variety of shocks and disruptions, including growing prices, geopolitical unrest, clogged supply chains, and regulatory changes. With new potentials and hazards for future growth and profitability, these events have put banks' adaptation and resilience to the test.
Based on our own data and research, we give in this study our analysis and insights on the performance and prospects of the worldwide banking sector. We also look at the topic of sustainable finance, which has become a top focus for banks and their customers as they try to match their operations with ethical and moral objectives. We want to give readers a thorough and forward-looking view of the trends, obstacles, and opportunities that will influence the banking industry in 2022 and beyond.
Our main findings are as follows:
1) As a result of increased interest rates and better margins, banks recovered from the pandemic in 2022, posting great revenue growth and profitability. However, valuations remain low in comparison to other industries, and more than half of the world's banks continue to earn less than their cost of equity.
2) There is a widening divide between banks with various profiles in various nations, which is a reflection of the diverse degrees of vulnerability to geopolitical unrest and macroeconomic volatility as well as the variable degrees of their capacity to seize development opportunities and control costs and risks.
3) The top-performing banks distinguish themselves by adhering to four key principles: enhancing resilience, reimagining business models, speeding digital transformation, and embracing sustainability.
4) The "next era" of sustainable finance is beginning as banks engage clients from all industries on their transition strategies rather than just financing renewable energy. To support their clients' decarbonization initiatives, banks must create new competencies, products, and relationships. This poses both opportunities and problems for banks. In the sections below, we go into further detail about these conclusions.
Banks rebounded from the pandemic with strong revenue growth and profitability in 2022:
The COVID-19 epidemic and its economic and social repercussions have not deterred the world's banking sector, which has displayed amazing fortitude. Through a variety of relief measures, including loan moratoria, payment deferrals, credit guarantees, and fiscal stimulus, banks have played a crucial role in assisting individuals, companies, and governments. Additionally, banks have benefited from extraordinary monetary policy support from central banks, which have held interest rates at record-low levels and poured liquidity into the financial system.
These elements have contributed to banks' impressive revenue growth and profitability in 2022. Our estimate projects that worldwide banking revenue will increase by $345 billion to $5.1 trillion in 2022. In comparison to 2021, which was already a record year for banking revenue, this implies an increase of 7%. A sharp rise in net margins—the difference between interest income and expense—which accounted for 60% of the revenue growth—was the primary factor in this growth. In 2022, net margins increased globally by 18 basis points as interest rates surged after lingering for years near their cyclical levels.
The improvement in margins was broad-based across regions and segments:
In 2022, nearly all geographical areas experienced positive margin expansion, with North America leading the pack with a 28-basis point rise. Asia-Pacific (outside of China) was the lone exception, as margins fell by 4 basis points as a result of intense competition and low-interest rates. Similar gains in margins were observed in nearly all banking segments in 2022 (Exhibit 2). The biggest margin rise worldwide was in retail banking (including mortgages), which had a 23 basis point improvement. Corporate banking (including trade finance) saw a 16 basis point increase. Capital markets and investment banking (CMIB), the sole segment to see margin contraction, suffered a loss of 6 basis points as a result of decreased trading revenues.
The margin expansion greatly increased bank profitability in 2022. According to our projections (Exhibit 3), the worldwide bank return on equity (ROE) would be between 11.5 and 12.5 percent in 2022. Since 2008, just before the global financial crisis, this level has been at its highest. Additionally, it represents a stunning recovery from 2020, when the pandemic-caused recession caused global bank ROE to drop to an all-time low of 4%.
Additionally, the increase in profitability was widespread across all markets and regions (Exhibit 4). In 2022 compared to 2020, positive ROE growth was observed across all areas. In 2022, North America had the greatest ROE at about 15%, followed by China at about 14%. Western Europe had the lowest ROE in 2022, at roughly 6%, but it was still a huge improvement over its -1 % ROE in 2020. Similar to this, all banking divisions experienced positive ROE growth in 2022 when compared to levels in 2020. In 2022, CMIB had a ROE of about 13 percent, with retail banking close behind at around 15 percent. The ROE for corporate banking was the lowest in 2022 at roughly 9%, although it was still significantly better than its ROE of around 0%.
Global bank capitalization levels were also strengthened by the increase in profitability. Exhibit 5 shows our projection for the global bank Tier 1 capital ratio, which measures the proportion of high-quality capital to risk-weighted assets, at between 14 and 15 percent in 2022. This amount is the highest ever observed and is significantly higher than the legal minimum. This is a reflection of banks' cautious capital management strategies, which have included reducing dividend payments, share buybacks, and acquisitions in favor of organic growth.
Nevertheless, despite these encouraging changes, bank valuations are still low when compared to those of other industries. Our data shows that the overall global market capitalization reached a high of $16 trillion in 2021 before falling back to $14.5 trillion by May 2022. Traditional financial institutions account for 50% of this valuation, while specialists and fintechs account for the other 50%—an increase from a 30% share five years ago (Exhibit 6). This suggests that although specialists and fintechs trade at an average price-to-book ratio of about four, traditional banks trade at a price-to-book ratio of about one.
More than half of all banks in the world still earn less than their cost of equity, which we estimate to be roughly 10% globally, as shown by this valuation difference. According to our data, only 35% of banks worldwide saw margin increases produce returns above the cost of equity for the second half of 2022. This indicates that despite their increased profitability, the majority of banks are still destroying value for their shareholders.
The valuation difference also shows the market's misgivings about banks' capacity to maintain performance in the face of escalating risks and uncertainties. As we shall cover in the following part, banks are dealing with several connected shocks, some geopolitical and others related to the pandemic's lasting economic and social repercussions, that are aggravating fragilities and causing new obstacles to their continued expansion and profitability.
There is a growing divergence between banks with different profiles in different countries:
The global banking sector is not uniform; rather, it is made up of several markets, regions, and market segments, each of which has unique characteristics, exposures, and performance levels. The main causes of divergence that will affect the financial landscape in 2022 are highlighted in this section.
The instability of the macroeconomy is one cause of divergence. Unprecedented changes in economic activity, interest rates, inflation, and exchange rates have been brought on by the COVID-19 pandemic in many nations. These fluctuations have had a considerable impact on the income, expenses, and risks faced by banks. For instance, changes in interest rates have an impact on banks' net interest margin, which is the primary factor in determining bank profitability, as well as net interest income, which is the greatest component of bank revenue. Movements in inflation have an impact on banks' real returns, which are the distinction between nominal returns and inflation, as well as their loan losses; the higher the inflation, the less real worth of debt repayments are. Banks' foreign currency exposure—the gap between their foreign currency assets and liabilities—as well as their translation risk—the risk that exchange rate fluctuations would alter the value of their foreign currency earnings—are impacted by exchange rate changes.
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