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Banks Have Thrown $1 Trillion at Digital. Do Shareholders Care?

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Not all banks are being rewarded for their digital efforts.

Banks have invested $1 trillion in technology over the past four years to get their business out of the corner branch and into the digital sphere. Has it been worth it?

Naturally, both investors and executives have a lot of interest in the answer to that question. Since the financial crisis of the last decade, banks have struggled to earn any meaningful market premium as measured by price-to-earnings and price-to-book value. By these measures banking is the least valued of the major sectors, trading at bargain-basement multiples with a P/E of 10 and a P/BV of less than 1, according to data from S&P Capital IQ. Clearly, despite the fact that bank businesses have rebounded to show a decent return-on-equity that hovers around the cost of capital, investors aren’t very enamored with the future prospects for traditional banking.

Part of the reason banks have been investing so much in technology in recent years is to better align themselves with consumers’ increasing focus on digital and mobile. The business cases behind all of these investments were to drive improved economic performance that shareholders would then reward. Despite the weak sector performance, drilling down into individual bank stocks shows that, while some banks are seeing their digital transformation hit the bottom line, others are struggling.

To figure out what benefit banks may be seeing from their technology investments, Accenture analyzed 161 publicly traded retail and commercial banks from 21 countries through three lenses. First, bank earning calls, public statements and financial disclosures were examined to assess bank attitudes and actions toward technology. Second, third-party plaudits were gathered, such as trade publication digital innovation awards and independent studies of digital-focused metrics around customer satisfaction. Finally, experts from Accenture’s banking practice added their subjective judgment based on their experience and knowledge of the market and what is really happening under the covers at these institutions.

Of the 161 banks around the world, just over half are digital laggards, either with no coherent plans to go digital or just half-hearted efforts. Another nearly 40% (61) are digital active, doing many of the right things but lacking true institutional commitment and a cohesive approach or else they are struggling with execution. At the top of the pile, Accenture found 19 digital-focused banks that are fully committed to transforming themselves into digital-centric institutions.

When we look at economic performance through the lens of this digital maturity analysis, we see that there are clear returns for being a digital leader. Looking at the top, the digital-focused group, they have been able to raise their P/BV ratio 13% to 1.18 over the past 8 years. Not great when compared to fintech and big-tech valuations, but still an indication of increasing confidence in future returns. The second tier managed to eke out a 5% P/BV gain. The worry for the 50% of banks in the laggard category is that they saw their P/BV drop by more than 16%, to an average of 0.83. Clearly, that $1 trillion technology investment is drawing in shareholder support, but only for those banks who can tell a clear and compelling story.

We found that it’s not just hype and narrative creating the divergence in valuations. When you dig into returns, the digital-focused group are creating real separation in absolute ROE and rate of improvement. However, it is interesting to note that almost all of the gain in returns are coming from positive operating leverage and the ability to grow revenues faster than costs. Using 2007’s costs as the baseline, the top digital banks have slashed their costs (as a ratio of revenue) by more than half. The middle, digital active group, cut costs by about one-third. The rest managed a modest 2% reduction in costs. Among all three tiers, revenue as a percentage of assets fell in the period indicating margin compression across the industry. Only the top digital banks managed to boost operating income as a percentage of assets — from 1.17% to 1.29% — and it was all being driven by digital efficiency.

Extracting increased profitability from existing operations is a positive, but on another level, it must be disappointing for stakeholders who see other industries’ technological advancements creating rapid revenue growth and material customer acquisition – and strong share price growth with it.

The challenge for the banking industry is to translate digital investments from efficiency into growth, not just to support their stock prices but to fend off incursions on the banking business from the technology giants and fintech unicorns. There are signs a few banks are starting to reap that growth reward for being truly digital – DBS Bank in Asia and Spain’s Banco Bilbao (BBVA) are two examples of leading digital banks now beginning to show strong top-line growth.

As a group, digital-focused banks can shift into growth mode by focusing on expanding their balance sheets and using Open Banking regulations in Europe and elsewhere to broaden their loan and asset originations. Leveraging their large legacy infrastructures to be vendors of banking-as-a-service to other banks (and tech frenemies) is another logical step. And for all the lagging banks? It’s their job to follow the example of the digital leaders and try and catch up. The market is speaking.