Financial institutions are set for a once in a generation change

The primary role of a traditional bank providing financing and capital is set to be challenged further in a post COVID-19 world by non-banks, according PwC’s report, “Securing your tomorrow, today – The future of financial services,” which predicts that alternative providers of capital are set to become an even more important part of the global financial system.

In the last 10 years, aggregate lending in USD by non-banks has outstripped the pace of growth of traditional lenders, with non-banks seeing a compound annual growth rate (CAGR) of lending of 2.3%, compared to 0.6% CAGR for banks. This trend is likely to accelerate as declining core capital ratios – caused by asset impairments resulting from the COVID-19 pandemic – will limit the lending capacity of banks, particularly in Europe. Non-traditional sources of finance such as private equity, sovereign wealth funds, credit funds and governments themselves will need to step into the breach to finance the recovery and its aftermath.

In 2019, non-banks – including private equity funds and sovereign wealth funds – lent 41 trillion dollars compared to the 38 trillion dollars lent by traditional lenders. In particular, the analysis by PwC shows that private debt has seen substantial growth, which is set to propel the asset class into a significant category of non-bank lending. Since 2010, private debt has been growing with 11% CGAR.

For established financial institutions, the rise of alternative lending brings into question a bank’s role as a capital provider versus an intermediary, according to John Garvey, PwC’s Global Financial Services Leader, PwC US.

“The rise in alternative providers of capital and the impact of COVID-19 on traditional lenders has put a spotlight on how various funding models will evolve in the future. For traditional financial institutions, this shift will have a significant impact on their business model – and ultimately their bottom line. Banks need to rapidly think about alternative ways to participate in the value chain as the industry migrates to a platform-based model.”

For insurers and asset and wealth managers, the challenges are equally daunting.

The report argues that a combination of near zero interest rates and the rise of digital-only players will create tighter margins across product portfolios, thereby emphasising the need to digitise rapidly, gain cost efficiencies and register real gains in productivity. All of this will have to be completed as governments mandate more spending and reporting on ESG initiatives. Those that fail to do so are likely to be caught in the wrong end of the coming wave of deals and restructuring.

“While the financial services industry has stood up well in light of the pandemic, it will likely be hit hardest by second-order effects. The loss of employment, the closure of businesses, the increase in debt and the volatility in markets due to the pandemic and its after-effects, along with the continued low interest rate environment, will be negatively felt throughout the real economy for years to come. The challenge for the financial services industry is in how it is able to navigate this difficult environment while balancing cost cutting and investment. Those that execute best will be the ones to succeed,” said John Garvey.

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