Lessons from leaders in Latin America’s retail banking market

For the past several years, the performance of the global banking industry has been stable but unexciting, with moderate growth and profits. Latin America has been an exception, however, and is the fastest-growing banking market worldwide.

Between 2012 and 2017, banking revenue before cost of risk in the region grew at a compound annual growth rate of 12 percent in constant 2017 exchange rates, reaching $418 billion, according to McKinsey Global Banking Pools data. This is six percentage points higher than the global average and more than any other region.

Multiple factors contribute to this fast growth. Among them, Latin America has very low banking penetration compared to other regions. In several Latin American countries, 30 to 50 percent of the population over age 15 have an account with a financial institution, compared to more than 90 percent in countries like the US, UK, or Spain, or roughly 80 percent in China. Additionally, Latin America has a young and growing population that contributes to faster growth.

We expect Latin America to remain the growth leader in banking, and to continue closing the gap in banking penetration, with revenues increasing at around 10 percent per year over the next five years and reaching $675 billion before cost of risk (Exhibit 1).

1

Retail banking has been the center of growth, outperforming wholesale by two percentage points and growing at a rate of 12.6 percent between 2012 and 2017. Within retail, consumer finance has been the primary growth engine, and remains the most developed banking submarket in the region, representing more than one-third of after-risk revenues. However, in relative growth terms, microloans, deposits, and retail payments are the fastest-growing submarkets (Exhibit 2).

2

We expect retail and wholesale banking to grow at rates of 10.2 and 9.8 percent, respectively, through 2022, with consumer finance and mortgage as the strongest drivers of retail growth—although almost all retail banking products will thrive.

Latin America is also the global banking industry’s most profitable region. Overall return on equity (ROE) in 2017 was 14 percent, outperforming other global regions and more than doubling the 4–6 percent range of most developed regions (which for many countries implies that banks are not covering the cost of capital). Revenue is the primary factor in the region’s outperformance: interest margins over assets stood at 4.9 percent in 2017, 1.8 percentage points above the closest regions, and fee margin over assets at 1.3 percent. Latin America’s profit advantage is negatively offset, however, by its lower cost efficiency, with operating expenses at 3.9 percent of assets (1.5 percentage points higher than the next-closest region), and its poor asset quality, with provisions at 1.1 percent of assets.

National leaders (banks with total assets of more than three times their market average) are the clear winners in terms of average profitability levels, with a combined ROE of 15.2 percent. Large banks (total assets between the market average and three times the market average) and medium banks (assets of from one-quarter of the market average, up to the market average) are next at 13.6 percent and 13.1 percent ROE, respectively. The drivers of profitability are very different, however. While national leaders rely heavily on efficiency, large and medium banks rely on revenues (mostly on the margin side) and on asset quality, with a significantly lower provision ratio than national leaders and small banks.

Latin America’s small retail banks (assets less than one-quarter the market average) are the least profitable among the size groups, with average ROE of 3.9 percent, significantly below the cost of capital. This performance is driven by low return on assets (ROA) and a lower-than-average leverage ratio. ROA is significantly hurt by inefficient cost structures and asset quality.

What Latin America’s retail banking leaders have in common

To understand how leading banks achieve their superior margins, cost efficiency, and asset quality, we analyzed those banks with ROEs significantly higher than their peer size group; a number of winning practices emerged:

Winning practices for all banks

• Excellence in pricing. Most winning banks possess a distinctive ability to detect and capture pricing opportunities, and to prevent fee leakage; some leverage advance analytics techniques to do so at a granular level.
• Commercial productivity. Most winning banks achieve high revenue-to-cost ratios due to a very productive sales force, reaching up to 1,200 to 1,500 sales of products per retail relationship manager (RM). This performance is typically powered by commercial excellence programs that redesign how RMs identify and execute commercial opportunities.
• Superior risk assessment. Winning banks of all sizes have better asset quality than their peers, and most demonstrate better-than-average assessment of risk, allowing them to systematically capture a disproportionate share of customers with better credit.
• Best-in-class customer-centric segmentation and segment value proposition. Most winning banks focus on segments and develop tailored value propositions across five dimensions: products, services, relationship model, distribution model, and channels.

Winning practices for national leaders and large winners

• Relentless focus on efficiency. National leaders and large winning banks operate with highly efficient corporate centers and support functions, relentlessly seeking cost efficiency; many have multiyear programs that have included multiple cost-reduction levers, like lean process redesign or rightsizing.
• Higher-than-average digital marketing and sales. National leaders and large winning banks post higher-than-average shares of digital sales, reaching up to 15 to 20 percent of total sales; these numbers still trail digital leaders from other regions, but there is a clearly emerging Latin American digital “best in class.”
• Agility—nimble response to market conditions. National leaders and large winning banks are embracing agile practices to overcome the challenge of complexity and become less siloed; they aim to quickly reconfigure around multifunctional teams to launch new products and capture value. As with digital sales, Latin America’s most agile retail banks still trail global leaders, but they are gaining an advantage over their regional peers.

Winning practices for medium and small winners

• Focus on niche markets. Medium and small winning banks in Latin America often thrive by developing targeted value propositions for niche markets that are underserved by other banks; the three most common such niche markets are consumer finance and credit cards, un- and underbanked customers, and small and medium enterprise financing.
• Efficient (sometimes third-party) distribution models. Medium and small winning banks leverage alternative and cost-effective distribution and relationship models that overcome the scale problems that typically challenge smaller institutions; examples include digital-only, shared distribution networks (for example, with a retail firm), and telephone-only.

Lessons from international banks

The battle for profitability is one that many banks around the world are consistently engaged in, particularly in the very competitive and low-interest-rate markets of developed regions like North America and Europe. What can Latin America’s banks learn from the winners in these markets?

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According to our analysis, Latin American banks are already following many of the practices of winning banks around the globe, but there are a number of additional global practices that could provide additional competitive advantage for Latin American banks:

Initiatives that apply to all banks

• New fee-revenue streams. Latin American banks need to find new sources of revenue to compensate for the reduction of traditional banking revenues—without damaging customer experience and satisfaction; innovations could include ancillary revenues such as payments fees or loyalty program fees, but also the development of financial-services ecosystems.
• Next-generation IT architecture, infrastructure, and organization. Many banks in the region have successfully transformed their digital front end; fewer have transformed core IT processes and structure. Efforts on this front could lead to more sustainable digital growth and higher cost efficiency.
• Holistic digital transformation. Latin American banks must focus on full digital transformation, including the digital enablement of customer acquisition, customer journey redesign, automation and digitization of the back office, streamlining the operating model, and building a digital acceleration-execution model.
• Create a motivating culture of change, with shared vision and values. Latin America’s banks should follow the lead of winning banks globally by developing a culture that values change, collaboration, creativity, entrepreneurship, bottom-up innovation, and personal ownership.
• Cybersecurity. Another area where Latin American banks can learn from winning banks in other regions is to improve cybersecurity practices, including protecting critical information assets, securing the value chain, and defining the security operating model across lines of defense. This is particularly true today, with many recent attacks focusing on Latin American banks.

Initiatives that apply to national leaders and large winning banks

• Operational excellence leveraging digital and advanced analytics. As previously mentioned, Latin American banks have excelled in front-end digital transformation, but they need a parallel focus on operational excellence, including a significant reduction in product complexity and a reintegration of front- and back-end value chains with simpler, straight-through processing.
• Shared commodity services across banks. While the fragmented nature of the Latin American market will make it difficult, banks could start outsourcing and consolidating certain common services that are not part of their core business, including know your customer, procurement, and vendor management.

Growth and profitability in Latin America’s retail banking industry have been strong over the last five years, and we expect this trend to continue—provided that political and financial stability remains high in the region.

However, our analyses make clear that overall profitability does not guarantee individual profitability. There are significant differences in performance between winners and losers, and we anticipate these differences will increase in coming years as winners continue to adopt best-in-class practices.

Download Lessons from leaders in Latin America’s retail banking market, the full report on which this article is based (PDF–1MB).