March 23, 2015 - Corporate banks, a majority of which are plagued by declining economic profit, must take bold steps to adapt their business models or potentially suffer prolonged, painful periods of underperformance, according to a new report by The Boston Consulting Group (BCG).

The report, Global Corporate Banking 2015: The Look of a Winner, is being released today.

The latest in a series of BCG studies on the corporate banking business, the report explores the recent performance of leading industry players, examines five disruptive trends that they must cope with, and looks ahead to what winning corporate banking divisions will look like in 2020.

"While it would be premature to write the obituary for corporate banks as we know them," said Jürgen Schwarz, a coauthor of the report and the global leader of BCG's corporate banking segment, "today's players must markedly change how they do business if they hope to thrive in the future."

Recent Performance. According to the report, it has been a struggle to create value in corporate banking in many markets since the start of the 2007-2008 financial crisis. The 2014 edition of BCG's Corporate Banking Performance benchmarking, with more than 250 participants that serve small businesses, midmarket companies, and large corporations, showed that two-thirds of corporate banking divisions had returns on capital below the hurdle rate. Performing well in corporate banking is critical, the report says, given that it accounts for roughly half of the banking industry's global revenue pool. BCG estimates that corporate banking revenues will grow by 7 to 8 percent annually through 2020.

The challenge has been particularly severe in Western Europe, but also in Central and Eastern Europe, with median pretax returns below 10 percent in both regions. Even in relatively fast-growing markets such as Latin America and Asia-Pacific, players are battling against increasingly competitive margins, too much reliance on lending products, and rising loan losses.

BCG's 2014 benchmarking found that more than half of corporate banking divisions worldwide showed declining economic profit over the previous three years. North American banks stood out for above-avefit over the previous three years. North American banks stood out for above-average performance in terms of return on capital, but even their returns are trending downward as postcrisis competition intensifies. Western Europe, despite turnaround initiatives at many banks, has a majority of players with negative and declining economic profit, and more than half of Latin American players show declining economic profit.

The situation appears to be the reverse in Central and Eastern Europe, where more than half of banks show rising economic profit. In Asia-Pacific, about 70 percent of local players are on upward economic-profit trajectories.

The report says that in most regions, the gap separating top players from bottom ones has widened in recent years. In BCG's 2007 study, for example, there was a 14-percentage-point gap in return on regulatory capital between the top- and bottom-quartile players. In the 2014 study, this gap increased to 21 percentage points and widened in all regions except North America. Such divergence underlines a key point: corporate banks with the right business model can create value in all segments and regions, despite local or segment-specific challenges.

Five Disruptive Trends. According to the report, five key dynamics are forcing corporate banks to reshape their business models.

• Tighter Regulation. Players have only partly adjusted to the new regulatory landscape, and few banks have figured out how to optimally manage new regulatory cost pressures or manage portfolios in an analytically robust way.
• Shifting Client Needs. Most corporate bankers lag behind retail bankers in fundamental customer research, yet corporate clients are increasingly demanding customized, end-to-end solutions that are faster, simpler, and industry specific.
• The Digital Revolution. Many corporate banks have underinvested in digital technology, yet client preferences are changing rapidly, with fast-growing expectations of fully integrated solutions, lean processes, and 24/7 access via the Web and mobile devices.
• Disintermediation. Not only is the digital wave spawning new rivals that are positioning themselves between traditional corporate banks and their clients, but other competitors such as shadow banks and debt-capital-markets providers are also cutting incumbent corporate banks out of the picture by connecting borrowers directly with other sources of finance.
• Globalization. More midmarket companies are becoming active in international supply chains, yet many banks, under pressure from regulators (and in response to crisis-era losses), are retrenching with regard to their international footprints. There is thus a new risk that banking clients will forge relationships with other providers that can better serve their international needs.

Winning Players in 2020. According to the report, corporate banks need to take the following steps in order to generate profit above the cost of capital in 2020: adopt a rigorous portfolio strategy, enhance industry specialization, develop new client solutions, build new credit capabilities, drive value-based pricing, improve digital models and big-data capabilities, pursue operating excellence, and embed a high-performance organization. The report details how players can use these initiatives to raise their competitiveness.

"Corporate banks that avoid fundamental change will continue to struggle, playing catch-up to faster-moving and more forward-thinking rivals," said Pieter van den Berg, a coauthor of the report and BCG's regional segment leader for corporate banking in North America. "Courageous decisions will be required, and sooner rather than later."