How to improve banking stock valuations?

Boston Consulting Group (BCG) takes an in-depth look at the global banking sector and offers recommendations to improve the sector's stock market valuation. According to the report, valuations could double in the coming years (estimated global impact for the sector of a $7 trillion valuation improvement) if a radical change in the business model is implemented. In this new model, banks will need to create value for shareholders and society, driving economic growth and financing the climate transition, but to succeed in their transformation in a profitable way they will need the active support of governments and cooperation with regulators.

Main highlights of the report:

• Banks valuations across the globe have been penalized since Global Financial Crisis: In 2022, roughly 75% of bank equity traded below a price-to-book ratio of 1.0. The discount for bank stocks shows an increase from about 20% in 2006 to nearly 60% in 2022, compared with the stocks of other industries. Drop in profitability is one of the main drivers of this negative evolution as the average return on equity (RoE) has declined by more than 450 basis points since the GFC, and many banks do not earn their cost of equity.
  
  
• Unlocking $7 Trillion in Value. BCG doesn’t believe that banks can return to profitability and valuations levels existed prior to the GFC. However, banks can roughly double current valuations in the coming years by setting a bold agenda to promote growth, increase productivity, and become more appealing to investors. In this regard banks will need:
  
  
  • Far-higher productivity (40% higher than nowadays), radically reducing the cost of complexity, and capital exposure to low-return asset classes, counting with a modern platform operating model, reimagining functions and leveraging AI and generative AI. The new operating model will have to deliver vastly more impact from data and technology as well as help build strategic partnerships and capabilities for competitive advantage.
    
    
• Banking tech investments and digital challenges: Banks are spending more on it than other sectors, but only a small share of the total spending (between 20-25%) is on truly innovation and modernization. Transformation cannot continue building, bit by bit.
  
  
• Climate transition: Governments will place high expectations on banks to be role models and catalysts for change on climate transition and corporate social responsibility and this will add additional pressure on profitability in the short term.
  
  
• Regulators Should Collaborate with Banks: Such cooperation can reinforce banking profitability without compromising systemic stability. They should ensure a level playing field with new entrants, adopt new agile approaches to rules like the test-and-learn paradigm, push for banking consolidation, and encourage digital assets, and digital public infrastructure and industry utilities, among other things.