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Future of long-term finance

Jean-Christophe MieszalaJune 16, 2014

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Other productiveinvestment

Infrastructure

Residentialreal estate

Global investment

In 2009, McKinsey warned that In 2030, yearly investments will be 2,5 times 2008’s, resulting in a potential “capital crunch” of $2 trillion (2/2)

2030

24.0

15.4

3.7

4.9

2008

10.7

7.0

1.62.1

1981

4.5

3.10.7 0.8

SOURCE: Economist Intelligence Unit; Global Insight; McKinsey Global Economic Growth Database; Oxford Economics; World Development Indicators of the World Bank; MGI Capital Supply & Demand Model; McKinsey Global Institute

2030 global savings

~22

$ Trillions, constant 2005 prices and exchange rates

$2 trillion shortfall


First order effects of the financial crisis at individual banks have fueled adebate about broader economic effects

2SOURCE: McKinsey; Group of Thirty; EC

… Fostering a debate about broader economic effects

▪ Politicians and regulators are especially concerned about a potential undersupply of long-term corporate credit ("credit crunch") threatening future economic growth

▪ This has been raised by the Group of Thirty: “Woringly, we conclude that the current systems […] do a poor job in supplying long-term finance from diverse providers to lenders spread across sectors and the globe."

▪ And the European commission just published a Green Paper with 30 consultation questions to initiate a broad debate about "how to foster the supply of long-term financing and how to improve and diversify the system of financial inter-mediation for long-term investment in Europe"

Some segments (e.g., structured finance, Large Caps) face a short-term, and mostly delicate market balance at best

Many incumbents refocus on core segments and strengthening their credit and commercial processes

Banks withdraw from long-term lending causing corporates to seek alternative funding channels

First order effects at individual banks


The working group on long-term finance (G30)

3SOURCE: Group of Thirty

Project director

Charles RoxburghMcKinsey & Company

Observers

Peter BuombergerZurich Insurance Group Ltd.

Steven HottigerUBS

Anna MarrsStandard Chartered PLC

Experts

Several McKinsey PartnersMcKinsey & Company

Stuart P.M. MackintoshGroup of Thirty

Working group

Jean-Claude TrichetChairman, The Group of ThirtyHonorary Governor, Banque de FranceFormer President, European Central Bank

Peter SandsGroup CEO, Standard Chartered PLCFormer Group Finance Director,Standard Chartered PLC

Domingo CavalloChairman & CEO, DFC Associates, LLCFormer Minister of Economy, Argentina

Roger FergusonPresident & CEO, TIAA-CREFFormer Vice Chairman, Board of Governorsof the Federal Reserve System

Geoffrey BellExecutive Secretary, The Group of ThirtyPresident, Geoffrey Bell and Company, Inc.

Martin SennCEO, Zurich Insurance Group Ltd.Former CIO, Swiss Life Group

E. Gerald CorriganManaging Director, Goldman Sachs Group, Inc.Former President, Federal Reserve Bank of New York

Gerd HaeuslerCEO, Bayerische LandesbankFormer Managing Director & Vice Chairman,Lazard & Co.

William J. McDonoughFormer President, Federal Reserve Bank of New York

Jaime CaruanaGeneral Manager, Bank for International SettlementsFormer Chairman, Basel Committee on Banking Supervision

Guillermo de la DehesaDirector & Member of the Executive Committee,Banco SantanderFormer Deputy Managing Director, Bancode España

Jacob A. FrenkelChairman of the Board of Trustees,The Group of ThirtyChairman, JPMorgan Chase InternationalFormer Governor, Bank of Israel

Richard A. DebsAdvisory Director, Morgan StanleyFormer President, Morgan Stanley International

Sir David WalkerChairman, Barclays PLCFormer Chairman, Morgan StanleyInternational, Inc.

Philipp HildebrandVice Chairman, BlackRockFormer Chairman of the Governing Board,Swiss National Bank

Mark CarneyGovernor, Bank of CanadaChair, Financial Stability BoardMember of the Board of Directors,Bank for International Settlements

Jose ViñalsFinancial Counsellor & Director of Monetary and Capital Markets, IMFFormer Deputy Governor,Banco de España

John HeimannSenior Advisor, Financial Stability InstituteFormer US Comptroller of the Currency

Jacques de LarosièrePresident, EurofiFormer Managing Director, IMF

Leszek BalcerowiczProfessor, Warsaw School of EconomicsFormer Deputy Prime Minister & Ministerof Finance, Poland

McKinsey Global InstituteMcKinsey & Company

Providers of funds

SOURCE: McKinsey Global Institute.

Intermediation system Users of funds

Capital markets

Long-term investmentFinancial intermediaries

Banks

Insurance companies

Other asset managers

Sovereign wealth funds

Pension funds

Alternative investment vehicles

Sources of funds

Domestic

▪ Households

▪ Corporations

▪ Government

Foreign

▪ Households

▪ Corporations

▪ Government

Self-financing instruments

Framework for understanding the provision of financingfor long-term investment

Household income/wealth

Government taxreceipts

Corporate retainedearnings Maintenance of

physical capital

R&D

Education

Equipment and software

Property, plant and equipment

Commercial real estate

Infrastructure

New stock of residentialreal estate, for emergingeconomies

Other

Bonds

Equity

Long-term investment typically represents 25–30% of GDP, though it can be much higher in economies undergoing rapid economic transformation


Long-term investment breakdown by asset type for 9 sample countries

Percent of GDP, most recent data (2011 or 2010), country sample represents over 60% of world GDP

3%

10%

4%

6%

3% 6%6%

9%

9%

4% 5%

1%

2%2%2%1%

3%

2%

26%

0%

5%

6%

4%

26%

1%

6%

10%

2%

35%

24%

2%

7%

6%

5%

24%

3%

7%

8%

3%

27%

2%4%

7%

6%

2%

28%

3%

11%

5%

3%

29%

13%

14%

4%2%

51%

6%

10%

5%3%

6%

8%

3%

Residential real estate

R&D

Education

Infrastructure

Equipment and Software

CRE and other structures

Total investmentUSD trillion

3.6 0.6 1.0 0.8 3.8 0.6 0.3 1.6 0.4

Developed markets Emerging markets

Tangibles

Intangibles

In a consensus growth scenario, long-term investment is projected to grow significantly by 2020

USD trillion (real)

2020 (F)

18.8

1.6

3.6

5.4

3.1

2.4

2.8

2010

11.7

0.92.4

3.5

1.81.4

1.7

R&D2

Education

Equipment

Other structures

Infrastructure


1 Sample countries include Brazil, China, France, Germany, India, Japan, Mexico, UK, and US, representing 60% of world GDP in 2010.2 Research and development.3 Cumulative annual growth rate.

Constant 2010 prices, constant exchange rates

CAGR3

4.9%

5.2%

5.3%

5.7%

4.2%

4.5%

5.2%

Real investment by type for sample countries1

USD trillion (real)

2020 (F)

18.8

6.5

2.6

1.9

2.7

5.2

2010

11.7

3.0

1.41.6

2.2

3.5

China

Other emerging

Japan

W Europe

USA

CAGR2

4.9%

3.9%

2.1%

1.8%

6.3%

7.9%

Investment evolution by region for sample countries1

Percent of GDP

30% 34% 30% 34%



Talent 165–265

Infrastructure 270–320

Big data1 155–325

Trade 200–590

Energy 380–690

Example: the five game changers which substantially raise US GDP by 2020 require significant investments

Incremental annual GDP by 2020$ billion

SOURCE: Economist Intelligence Unit; IHS Global Insight; McKinsey Global Institute analysis

1 Figures reflect additional GDP in retail and manufacturing sectors only. Big data could also produce cost savings in government services and health care ($135 billion–$285 billion), but these do not directly translate into additional GDP.

Note: These figures are based on a partial-equilibrium analysis that estimates only first-order effects and therefore cannot be summed to calculate the full economic impact.

Low estimate High estimate

$600 billion

$1.7 trillion

% of 2020 GDP

3.7

3

1.7

1.7

1.4

Long-term impact is

even greater

2030 GDP impact

Roughly 40% of long-term investment is financed through equity, bonds, or loansFinancing type as a % of total investment, total in USD trillion for sample countries1

1 Estimates for a typical global project based on data from sample countries including Brazil, China, France, Germany, India, Japan, Mexico, UK, and US, representing over 60% of world GDP in 2010.

2 Internal financing here defined as financing from household income/wealth, corporations’ retained earnings/cash holdings.3 Loans for residential and commercial real estate are as originated; depending on the country, a large portion of these loans could be subsequently securitized.4 Typical commercial real estate investment (including in existing structures) used as a proxy for investment in new commercial structures.5 Total debt and equity financing increase as a share of capital expenditure for nonfinancial corporations across the sample of countries.6 Research and development.

R&D6

0.8

25-30%

70-75%

Education

2.1

5-10%

75-85%

10-15%

Infra-structure

1.4

5-10%

20-25%

5-10%

60-65%

0

Equipment and software5

3.5

5-10%

25-30%

15-20%

45-50%

Commer-cial real estate4

1.8

60-70%

30-40%


1.6

70-80%

20-30%

Bonds

Loans3

Equity

Government

Internal financing from households and corporations2

100% =

2011 LT investment for sample countries1

11.2

0-4%

30-33%

0-5%

25-30%

30-33%

Financing by type of investment


Government accounts for about 30% of long-term investment in most countries

Long-term investment breakdown by sector

Percent of total long-term investment, most recent data (2011 or 2010), Country sample represents over 60% of world GDP

Total long-term investmentUSD trillion

3.6 0.6 1.0 0.8 3.8 0.6 0.3 1.6 0.4



4344

4642

54

63 29

44 45

18 22 27 2615

20

38

23 24

31

100%

3427

3239

17

34 32 31

Households

Corporations

Government

Banks provide over 50% of long-term external financing1 outside the US, mainly through residential mortgages

1 Long-term external financing here includes NFCs’ (nonfinancial corporation) book equity, nonfinancial corporation bonds, ABS/MBS (Asset-backed/mortgage-backed securities), longer maturity nonfinancial corporation loans, commercial real estate loans, and residential mortgages. Part of book equity is changes in retained earnings, which could be classified as internal.

2 Calculated by dividing total market capitalization by the average price-to-book ratio for non-financial corporations for each economy, and therefore covers only public (listed) companies. Due to data unavailability, the equity of private companies is not included.

3 Used Bank for International Settlements data for bonds outstanding to be consistent with corporate bonds data.4 We estimate the portion of 5-year maturities using a broader set of loans.5 US bank lending includes loans to domestic and foreign entities. The other countries only include domestic entities as counterparties.6 Asset-backed/mortgage-backed securities (ABS/MBS).

716

13 38

269 14

2314

6 11 12 14 11100%

Residential mortgages

Commercial real estateloans

NFC loans with maturities >5 years4

ABS/MBS6

NFC bonds3

NFC book equity of listed companies2

China

26

11

0

France

36

12

2

Germany

43

12

3

UK

43

9

21

US5

11

72

48Cap

ital m

ark

ets

Ban

kin

g

Types of domestic long-term external financing outstanding, 2011

Percent of total domestic long-term external financing

SOURCE: McKinsey Global Institute

Total as share of GDPPercent

129 156 100 115 73


Corporate credit is a big, solid business – but mostly lackluster in terms of growth and profitability2009 – 2011, in %

SOURCE: McKinsey Global Banking Pools; McKinsey estimate

8

-10

219

North America Europe

11

1 Average share of corporate credit business compared to total lending volumes (retail, public sector and non-banking financial institutions)2 After risk costs, assuming 90% risk weighting, 10% capital requirements and pre-tax 3 Including Mexico4 Rough estimates, only includes corporate and retail lending due to data availability 5 Includes the following products: cash management

and financing; excludes CMIB business of corporates

South America3 Africa4 APAC

Middle East

ClassicalCorporate Banking ROE2,5

Corporate credit ROE2

Volume CAGRCorporate credit1

as a share oftotal lending

620

3515

99

63

371918

5223

108

63231611

62


-20

0

20

40

60

80

100

120

140

160

180

2011100908072006

Financial crisis has further strongly affected corporate credit business and led to a massive decrease in banking profitsEurope (Western and CEE), in bps

SOURCE: McKinsey Global Banking Pools

Profit margin2Risk costs1

12

1 Actual risk costs calculated (EL = PD * EAD * LGD); divided by lending volumes2 Pre-tax profit from corporate lending; divided by lending volumes

Limited growth in most countries

Higher capital and funding charges

Increased risk costs and volatility

Significant reduction in placement channels

Key drivers affecting corporate credit profitability

Total Monetary Financial Institutions’ balance sheet assets, 2011Percent of total, totals in USD trillion

9%Other NFC loans as share of GDPPercent

37%

17%20% 16%

15%

35%

8%

17.6

42%

36%

41%

11.7100% =

France China4

Other NFC loans1

Foreign claims and other assets

Household loans and commercial real estate2

Securities, financial institution and government loans

6%

Germany

11.7

39%

35%

7%

UK

13.0

33%

47%

3%

US3

12.6

8%

45%

11%

19% 22% 27% 84%

1 Other NFC (nonfinancial corporation) loans include all nonfinancial corporation loans outstanding except for loans to commercial real estate sectors. 2 Includes loans to households (including mortgages and consumer credit) and loans outstanding to commercial real estate sectors.3 The US balance sheets do not provide the domestic/foreign asset distinction. Foreign claims are claims on all counterparties outside of the country.4 The data set for China covers banks and finance companies (excluding Peoples Bank of China). China does not provide details on securities as

opposed to loans (and advances), so the loan category includes securities to corresponding counterparties.


However, as a share of total bank assets, lending to NFCs other than for real estate is small, at less than 10% in developed economies

41

31

3526

2647

42

2841

46 4533

1810

Brazil

49

India

35

China

42

UK

29

Germany

19

France

29

US

31

Up to 1 year1–5 yearsOver 5 years


Bank lending2

2.8

4.2

Emerging markets loans

Developed markets loans

1 Calculated using the countries and weights from the chart on the right, using 0.5, 2.5, and 8 years as average maturities for each category.2 Bottom-up analysis of banks’ balance sheets for banks representing at least 70% of the total market share in each country, except for China and India

(top 10 banks used for both) and European countries (all domestic banks with assets above USD 5 billion used).

Bank lending is typically short-term, especially in emerging markets

Average maturity1 Proportions of maturities

Years Loans outstanding, percent


In the Eurozone, all net new bank lending to nonfinancial corporations is for maturities of 1 year or less

300

250

200

150

100

50

0

-50

-100

-150

-200

1H20122011201020092008200720052004200320022001200019991998

Over 5 years

1 to 5 years

Up to 1 yearEUR billion

Euro area annual net new lending to nonfinancial corporations

SOURCES: European Central Bank; McKinsey Global Institute.

Developed markets

Years

8.07.7

4.2

Investment grade bonds

High yield bonds

Bank loans

6.0

6.9

2.8

Investment grade bonds

High yield bonds

Bank loans

Years

Emerging markets

Average maturity of financial instrument1

1 Based on 3-year weighted average of maturity from sample countries (France, Germany, UK, US for developed markets; Brazil, China, India for emerging markets).


Corporate bonds have significantly longer maturities than bank loans in both developed and emerging markets

Yet, corporate bond markets and securitized loans remain small outside the US

55%

69%

79%

79%

81%

82%

92%

92%

94%

96%

45%

31%

21%

21%

19%

18%

8%

8%

3.3Other developed

United States 11.6

100% =

CEE & CIS 1.54%

India 0.86%

Middle East & Africa

1.2

China 8.6

Japan 5.6

Latin America 0.8

Other developing Asia

0.8

Western Europe 13.2

Corporate loans

Bonds

SOURCE: McKinsey Global Institute Financial Stock Database 2012, McKinsey Global Institute analysis.

USD trillion, year end 2011 Securitized loans as % of GDP

68%

3%

13%

4%

0%

2%

0%

0%

0%

0%

Debt financing of nonfinancial corporations per region


Despite ongoing discussions on its sustainability, the US financing model was confirmed after the crisis

29 30 30 29 28 27 26 2628

2931 33 34

39 39 40 38 38 40 41 42 4539 36 36 33

100% =

Bookvalue of equity

Bonds

Loans

2012

19

32

17

31

2010

17

33

16

31

2008

16

28

16

32

2006

14

33

13

33

2004

12

34

11

33

2002

10

30

10

32

2000

10

32

SOURCE: McKinsey Global Institute Financial Assets database; US Federal Reserve; CPAT; S&P; McKinsey Global Institute analysis

8

4

6

-1

0

9

Total financing outstanding to US non-financial corporationsPercentage, $ trillions 2000-07 2007-12

CAGR based on $ values, %

Institutional investors hold long-term assets, but have room to increase the proportion

Percent of portfolio, USD trillion

Institutional investors’ asset allocation, 2010 or latest

3729 29

38

18

67

616 16

7

51

100% =

Insurers

23

28

5

Households

85

31

Endowments& foundations

2

56

Sovereign Wealth funds

4

56

Pension funds

28

57

Mutual funds

24

55

Long term1

Fixed income2

Cash and other

1 Long term investment defined as equities and 80% of alternative assets; cash and other includes cash and 20% of alternative assets.2 Fixed income includes some risky long-term investment, such as corporate bonds, but the data is unavailable for a further breakdown.

SOURCE: McKinsey Global Institute, “The emerging equity gap: Growth and stability in the new investor landscape” (December 2011).

1 Excludes retirement assets.

As investors age in the United States and Europe,they shift to lower-risk assets

Household asset allocation by age cohort1

Percent of total assets

2437

100%

65 or more years old

27

31

5

35–65 years old

47

23

6

Equities

Fixed income

Cash and deposits

Other

48 55

100%

65 or more years old

20

22

3

35–65 years old

35

14

3

United States Europe

SOURCE: McKinsey Global Institute, “The Emerging Equity Gap: Growth and Stability in the New Investor Landscape” (December 2011).

The rise of defined-contribution pension plans in Europe will lead to a further shift out of equity

35

65

78

Defined benefitTotal assets3

= $850 billion

Defined contributionTotal assets4

= $341 billion

Share of equity in theasset allocationPercent of portfolio

65

35

78

22

Other financial assets

Equities

23

48

1

33

53

6

40

60

UK2Switzerland1 Netherlands

2010

2005

2000Defined-contribution share of totalpension assetsPercent

1 In Switzerland, defined-contribution stands for funds where the plan sponsor shares the investment risk and all assets are pooled. There are almost no pure defined-contribution assets where members make an investment choice and receive market returns on their funds.

2 UK data do not include personal and stakeholder assets but do include insurance-administered vehicles. If the latter were excluded as well, the proportion of defined-contribution assets would fall to 25%.

3 Allocation based on a sample of the following plans: ABP, PFZW, ATP, Alecta, Royal Dutch Shell, Universities Superannuation, FRR, and Varma.4 Allocation based on a sample of the following plans: Bayerische Versorgungskammer, BT Group, PFA Pension, Royal Mail, Royal Bank of Scotland

Group, Ilmarinen, British Coal Pension Schemes, and Barclays Bank UK.

0.7 2.3 1.0Tot. pension assets, 2010USD trillion

The share of defined-contribution pension plans has been increasing in Europe

Defined-contribution plans allocate less to equity than defined-benefit plans


European pension funds have been shifting outof equity, toward bonds and alternative assets

Percent of portfolio

5

45

39

14 2

64

2475

67

1810

16

58

141

39

44

1

44

44

1 11

27

282220

2011

27

38

7

2006

33

38

7

2001

36

35

9

Bonds

EquitiesAlternative assets

Cash

European pension funds asset allocation


NOTE: Numbers may not sum due to rounding.

European insurers have been decreasing their allocation to equitiesoutside their unit-linked businesses since 2001, in contrast to US insurers

15

1721

19

44 55 4756

6 9 8

10

6

5

9.6

22

Equities(unit-linked)

Cash 2

100% =

-11p.p.Equities

(not unit-linked)

Fixed income (not unit-linked)

Fixed income(unit-linked)

Other investments

2010

11

4

07

8.6

12

44

04

6.9

15

43

2001

5.9

Percent, USD trillion, 2010 exchange rates

Western European insurers’ financial assets US life insurers’ financial assets

47 4742 44

12 12 11 12

8877

2

5.3

30

Governmentbonds

Cash &equivalents

1

100% =

+2p.p.

Equities

Corporatebonds

Other fixedincome

Other

2010

32

3

1

07

5.0

36

2

1

04

4.2

30

2

1

2001

3.2

Percent, USD trillion



Deal values of syndicated loans, bn USD

▪ Different non-banking players have significantly increased their participation in syndicated lending deals

▪ The number of acting institutions1 is still limited but expected to increase severely

▪ A lot of non-bank activity is already taking place in the bilateral space and is also likely to grow

Insurance companies and other non-bank investors have significantly increased their engagements in structured finance

24SOURCE: Dealogic; McKinsey

1 Top 3 players among insurance companies engaged in Germany are Allianz, Massachusetts Mutual Life and Zurich

United Kingdom

Germany

CAGR

CAGR

2,6% 3,7% 4,8%7,6%

2012

92.4%

+2%

88100% = 78

97.4%

195

96.3%

2009

+48%

95.2%

10 11

199

EXAMPLE

2,0% 1,7% 2,5%

6,3%

98.0%

100% =

-11%

+31%

77

93.7%

98.3%

107106 132

97.5%

G

Non-bank Bank

Due to high savings and fast GDP growth, emerging markets’ share of financial assets is projected to nearly double by 2020

1 Assumes consensus GDP forecasts for individual countries and that emerging markets’ currencies appreciate vis-à-vis the US dollar.

19

14

9

9

9

United States

Western Europe

Japan

Other developed

China

Other emerging

2020F1

391.5

24

22

17

19

2010

198.1

29

27

10

11

2000

113.1

35

34

53

Emerging markets’ financial assetsUSD trillion

8 41 141

Percent, USD trillion

Total financial assets, 2010–20F



Illustration: The banking sector in China is expanding steadily

133 686

113 287

94 249

80 923

64 15054 120

43 95037 456

32 01427 65423 077

+19% p.a.

20122011201020092008200720062005200420032002

1 Refer to real GDP growth rate

SOURCE: PBOC; NBSC

Banking asset

RMB billions

In the corporate sector, investment is mainly financed through retained earnings in developed markets and debt and equity in emerging markets

SOURCE: McKinsey Corporate Performance Analysis Tool, McKinsey Global Institute analysis.

1 Total annual change in debt and equity financing as % of capital expenditure used to proxy share of external financing for largest public nonfinancial corporations by market share; capital expenditure includes corporate investment in tangible assets and does not include R&D or education.

2 For Mexico, only 97 companies are available; for Brazil, China, France, and Mexico, 2001–2010 average used due to lack of data for previous years.

Share of capital expenditure financed through debt and equity1

Average debt and equity financing as share of capital expenditure, 1995–2010, percent2

Ø 34%

Japan

20

France

35

Ger

30

UK

48

US

38


Ø 75%

Mexico

63

Brazil

97

India

79

China

60

Having driven a substantial portion of flows from 2000 to 2007, cross-border loans dramatically fell away during the crisis

1 Flows defined as net purchases of domestic assets by nonresidents (including nonresident banks); total capital inflows comprised of inward foreign direct investment and portfolio (e.g., equity and debt) and lending inflows.

Total cross-border capital inflows1, 1980–2011USD trillions, constant 2011 exchange rates

Percent global GDP

5 5 13 15 6

8

6

4

2

0

-2

-4

4.85.8

2.0

2007

11.7

20052000

4.9

19951990

12

10

2012

4.6

Loans and deposits

Bonds

Equity

Foreign direct investment

SOURCE: International Monetary Fund, McKinsey Global Institute.

21

Emerging markets2

Emerging markets2

Developed markets4

Developed markets4

Long maturityShort maturity

0.50.90.7

3.2

6.0

FDIEquityBondsLong-term bank claims4

Short-term bank claims3

Across both emerging and developed economies, cross-border bank claims have been more volatile than bond and equity flows

SOURCE: Bank for International Settlements, International Monetary Fund, McKinsey Global Institute.

Coefficient of variation of inward cross-border flows by maturity1

2000Q1-2011Q4

1.71.71.82.4

0.7

1 Coefficient of variation defined as standard deviation normalized by the mean; calculations are made on quarterly data.2 Sample includes 29 developed markets and 120 emerging markets.3 Bank net acquisition of cross-border loans and other debt assets in emerging and developed economies, with maturity less than or equal to two years.4 Bank net acquisition of cross-border loans and other debt assets in emerging and developed economies, with maturity more than two years.

Higher value means higher volatility


Since 2007, Eurozone banks have reduced foreign claims by $3.9 trillion, $2.9 trillion of which was intra-European…

317

-422

-822

-2,941

-133

-944

-681

-1,183

-3,866

1,729

2,025

1,609

304

5,668

1,382

509

1,182

Change

$ billionCompound annual growth rate (%)

8,737

Eurozone bank claims on:

SOURCE: Bank for International Settlements; McKinsey Global Institute analysis

1 Includes banks from Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Netherlands, Portugal, and Spain. 2 GIIPS comprises Greece, Ireland, Italy, Portugal, and Spain.

Consolidated foreign claims of Eurozone reporting banks(includes loans and other foreign financial assets)1

By counterparty location, constant 2011 exchange rates

4Q99–4Q07

GIIPS2

Other Eurozone

United Kingdom

Other Western Europe

Total Western Europe

United States

Other developed

Developing countries

Total

$ billionCompound annual growth rate (%)

3

-6

-9

-4

-6

-8

13

12

16

12

13

13

6 -7

-814

4Q07–1Q13

-1217

30


GIIPS2 capital inflows

$ billion, constant 2011 exchange rate

… Fueling a Euro-crisis that was only halted by Eurosystem flows

SOURCE: ECB; individual central bank balance sheets; Eurostat; press releases; McKinsey Global Institute analysis

-284-481

-151

203

312

3Q123

166

432

17

11

253

686

48

10

255

392

14

09

249

46

08

470

157

07

1,195

5

1,190

2006

1,259

-9

1,268

Eurosystem flows1Private flowsIMF

1 Includes inflows via EFSF/ESM, bond purchase programs, and the TARGET2 system.2 GIIPS comprises Greece, Ireland, Italy, Portugal, and Spain.3 Non-annualized total inflows up to 3Q12.

McKinsey & Company |SOURCE: Bank for International Settlements; McKinsey Global Institute analysis

Advanced-economy banks’ cross-border claims, by nationality of bank $ trillion, constant 2011 exchange rates

14

8

7

2

9.1+1.7

Japan2

Australia

Canada

United States1

1Q13

3.9

0.71.1

3.4

2007

7.4

3.4

0.5 0.72.8

United Kingdom3

11.0

GIIPS

3.0 16.9

-3.2

Other Western Europe

Other Eurozone

1Q13

2.8

4.0

7.4

2.8

2007

20.1

3.2

2.9

-2

-7

6

-2

2

-8

1 In 2009, US banks added a large amount of off-balance assets bank on their balance sheets. To ensure comparability between 2007 and 1Q13 figures, the data in the exhibit assumes these assets were on bank balance sheets in both periods.

2 In nominal $, Japanese bank foreign claims increased by $0.9 trillion between 2007 and 1Q13.3 In nominal $, UK bank foreign claims increased by $0.05 trillion between 2007 and 1Q13

Europe Other developed countries

Compound annual growth rate, 2007–1Q13 (%)

US and other developed country banks have expanded foreign assets—but not enough to offset the decline ofEuropean banks

32


Countries to worry about are those heavily dependent on foreign investors as well as with large current account deficits

-8.2

-2.8

1.7

-3.6

2.9

-3.4

-6.3

-0.8

-5.9

2.6

-5.1

0.7

-2.3

4.0

-3.5

Current account deficit% of GDP

Foreign exchange reserves1

% of GDPBonds owned by foreigners% of total bonds

37

20

24

24

23

14

12

14

12

7

7

32

42

22

16

13

13

13

14

8

8

10

10

1

1

3

2

0

1

India2 43

Thailand 7

Brazil 12

Russia 17

Chile 20

South Africa 22

Philippines

Indonesia 40

Poland 42

Hungary 44

2China

Ukraine2 69

Colombia 26

Turkey 36

Mexico 38

26

2012 dataCountries at risk

14

35

22

13

14

15

10

30

27

16

48

16

41

13

16

Purchased 2009-12 Purchased until 2008

SOURCE: McKinsey

Restoring government debt to 60 percent of GDP by 2030 will require painful fiscal adjustment in many countries

NOTE: Countries are assumed to undergo a gradual transition in their primary balance over 2011–20 and maintain a constant primary balance after 2020.1 Japan’s target for fiscal adjustment is set at 80 percent of GDP.2 Switzerland’s target level is to stabilize debt at the end-2011 level by 2030.

SOURCES: International Monetary Fund Fiscal Monitor October 2012; McKinsey Global Institute.

-1.1

0.9

6.2

4.3

4.3

5.6

5.2

5.8

4.5

10.5

9.4

10.6

11.4

12.8

20.3

Required adjustmentfor G20 advanced countries

Switzerland2

Germany

Portugal

Australia

Canada

Italy

Belgium

France

Netherlands

Greece

United Kingdom

Spain

Ireland

United States

Japan1

Fiscal tightening required 2011–20 to meet gross government debt target of 60 percent of GDP by 2030

Percent of GDP

Government austerity plans may reduce future infrastructure investment, since they currently fund over half

Percent

Japan

Germany

France

US

NOTE: Public investment includes investment in highways and streets, transportation, power, sewer systems, water systems, education and health care structures. Private investment includes private investment in nonresidential structures in power, communication, and other (about 30% of total, including religious, educational, vocational, lodging, railroads, farm, and amusement and recreational structures, net purchases of used structures, brokers' commissions on the sale of structures, roads and highways).

77%

59%

54%

55%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

20001990198019701960 2011

Country long-term averagePercent

Public share of infrastructure investment



As current monetary policy ends up, Government will face increased pressures…

840

360120

146

Net savings on debtfrom lower rates

Central bankremittances

United Kingdom

15939

Euro area

3644

United States

986

Estimated cumulative net savings on debt, 2007–12Constant 2012 exchange rate $ billion

% of government debt

3.1% 6.7%7.3%

% of GDP 3.0% 6.4%6.3%

SOURCE: McKinsey


… as well as parts of the banking industry

0

0,5

1,0

1,5

2,0

2,5

3,0

3,5

2012111009082007

SOURCE: Federal Deposit Insurance Corporation; Eurostat; Bloomberg; McKinsey Global Institute analysis

Banks’ effective interest margins—spread between effective rate received on assets and paid on liabilities%, annual values

Banks’ net interest income$ billion

388

303

177180

163

20122007

216

+0.63

-0.15

-0.36-25%

+28%

-1%


In the end, the European economy in particular faces several serious challenges

SOURCE: Team analysis

1 The challenge of financial disintermediation

2 The deleveraging challenge 3 The challenges posed by the decline in cross-border flows

McKinsey & Company | 38

Challenge n°°°°1 - Disintermediation: the financing structure of the economy is fundamentally different in Europe from that of the USA

29 30 30 29 28 27 26 26 28 29 31 33 34

39 39 40 38 38 40 41 42 45 39 36 36 33

100% =

Bookvalue of equity

Bonds

Loans

2012

19

32

17

31

2010

17

33

16

31

2008

16

28

16

32

2006

14

33

13

33

2004

12

34

11

33

2002

10

30

10

32

2000

10

32

SOURCE: McKinsey Global Institute Financial Assets database; US Federal Reserve; CPAT; S&P; McKinsey Global Institute analysis; Eurostat; CPAT; S&P

8%

4%

-1%

0%

6% 9%

CAGR based on values

2000-07 2007–12

Net interest impact on corporations

THE ISSUE OF FINANCING THE ECONOMY – DISINTERMEDIATION CHALLENGE

65 66 71 71 71 69 70 69 73 71 68 67 65

100% =

Bookvalue of equity 25

8

2000

6

27

7

Bonds

Loans

2012

10

26

10

10

24

9

2010

10

23

9

9

20

9

2008

9

208

9

23

7

2006

8

23

8

7

23

8

2004

6

21

9

6

20

9

2002

6

20

8

6

7% 2%

3% 5%

6% 9%

13

Total financing outstanding to EU non-financial corporationsPercentage, $ trillions

Total financing outstanding to US non-financial corporationsPercentage, $ trillions

McKinsey & Company | 39SOURCE: Haver Analytics; Bank for International Settlements; national central banks; McKinsey Global Institute

1 Includes all loans and fixed-income securities. Excludes asset-backed securities and mortgage-backed securities.2 Q2 2013 data.NOTE: Numbers may not sum due to rounding.

Total debt,1 Q1 2013, % of GDP

Challenge n°°°°2 - Deleveraging is a paramountchallenge for many countries (e.g., UK, Spain)

THE ISSUE OF FINANCING THE ECONOMY – DELEVERAGING

3 2

10 largest mature economies Eurozone-crisis countries

Households

Nonfinancial corporations

Financial institutions

Government

92

80

84

106

78

96

227

94

111

124

88

89

58

65

101

UnitedKingdom2

129

Japan2

91

49321196

511100 119

50

45

284

411Spain

98111 359France

9483 346Italy

3894115 331SouthKorea

8558 289Germany

298765 287Australia

3979 285UnitedStates2

5360Canada

110

92

129

227

94

111

122

101

124

177

88

89

75

106

91

80

65

96

78

58

84

72

411129 91

UnitedKingdom2 49396 211

289Germany

2987

33194

85

Greece

115

342

38

58

50

94

France

74

83 34645

20

Italy

SouthKorea

28765

Canada

Australia

39

284

79 285

60

UnitedStates2

384135 36Portugal

98

53

111 359

Spain

790

511Japan2

349202Ireland

119100

McKinsey & Company | 40

Challenge n°°°°3 - All types of capital flows have declined since 2007, and cross-border lending accounts for two-thirds the totalChange in total cross-border capital flows, 2007–12$ trillion, constant 2012 exchange rates

SOURCE: IMF Balance of Payments; McKinsey Global Institute analysis

Note: Numbers may not sum due to rounding.1 Includes primarily loans, currency and deposits, as well as a small share of trade credit. Excludes operations of foreign affiliates.

THE ISSUE OF FINANCING THE ECONOMY – CROSS BORDER FINANCING

0.1


0.8

0.1

11.3

2007

0.7

Loans and deposits1

1.9

3.2

5.0

0.3

3.5

Debt securities

0.4

Equity securities

1.6

1.20.4

2012

Rest of World

Western Europe and UK

3 3


Banks 2012

… And possibly a fourth challenge

SOURCE: Coalition

3

6

7

8

10

10

11

11

11

14

8

10

14

13

18

17

19

18

21

25

1 Includes Investment banking / Origination &Advisory ,Fixed Income Credit and Currencies, Equities Sales & Trading and Proprietary trading

Global CMIB1 revenue

USD Billions

H1 2013

In CMIB, 6 out of the top 10 banks are American. Only one is headquartered in the Euro zone


All proposals by the Group of Thirty in detail

40

Objectives Proposals

Ensure investors arebetter able to take a long-term horizon in their investment decisions

Create new intermediaries and instruments geared toward the provision of long-term finance

Develop debt and equitycapital markets in order to promote a broadspectrum of financing instruments

Ensure that cross-borderflows support the efficient global allocationof capital to long-term investment

Strengthen systemic analysis when setting future regulatory policy

▪ National regulators and international bodies such as the IMF, World Bank, OECD, and the Financial Stability Board should propose new best-practice guidelines to promote long-term horizons in the governance and portfolio management of public pension funds and sovereign wealth funds

▪ National policy makers should consider steps to differentiate between short-term and long-term debt (whether public or private), and weighing the pros and cons of phasing out the preferential treatment of sovereign debt in insurance and bank regulation over an extended time horizon

▪ The Financial Stability Board, in coordination with relevant standard-setting bodies, should review the regulatory and accounting treatments of assets held with long-term horizons to avoid excess focus on short-term market volatility

▪ Create new instruments to enable the public sector to leverage private sector capital for long-term financing

▪ Create dedicated long-term financing institutions

▪ Foster the development of long-term pension and insurance-based savings by, for instance, setting up compulsory auto-enrolled savings programs

▪ Redirect structural surpluses in national savings to diversified sovereign wealth funds with a long-term investment mandate

▪ Implement the Financial Stability Board and standard-setting bodies’ regulatory reforms to transform shadow banking into resilient market-based finance

▪ Promote development of corporate bond markets and securitization of long-term debt, particularly in Europe and emerging markets

▪ Develop the infrastructure for capital markets in emerging economies to lengthen financing horizons and diversify sources of funding

▪ Remove the bias against equity in countries where it is present

▪ Support the international diversification of investment portfolios in both developed and emerging markets

▪ Move gradually toward liberalization of capital accounts in emerging markets while maintaining financial stability, using macro prudential policy tools

▪ Policy makers should consider the systemic impact of ongoing and future regulatory changes on long-term investment

▪ National authorities should improve the collection of data statistics on the supply of and demand for global long-term finance

I

II

III

IV

V

SOURCE: Group of Thirty


The EC has done their own analysis and has asked for advice via 30 consultation questions until end of June

41SOURCE: EC Green Paper

Themes Major concerns seen by EC

The supply of long-term financing and characteristics of long-term investment

▪ Public resources should not replace private financing

▪ Corporate savings have increased for LCs – SMEs suffer from lack of liquidity

▪ Households are more and more preferring short-term savings

▪ FDIs made a recovery in 2011 – but after a steep decline in recent years

Enhancing the long-term financing of the European economy

▪ Commercial banks are hit by the new regulation (deleveraging, etc.)

▪ National and multilateral development banks should not crowd-out private financing – they should strive to catalyze private financing in areas where it is slow to come forward

▪ Institutional investors are partly also suffering from upcoming regulations (Solvency II) or are lacking the required skills (risk and liquidity management)

The capacity of financial institutions to channel long-term finance

The efficiency and effective-ness of financial markets to offer long-term financing investments

Cross-cutting factors enabling long-term saving and financing

The ease of SMEs to access bank and non-bank financing

▪ Only LCs have an access to European bond markets

▪ Covered bond markets are fragmented along national lines

▪ Securitization needs to be mobilized again – especially with simple structures for SMEs

▪ European project bond market initiative still at small scale

▪ Taxation often favors debt over equity investments

▪ Accounting principles sometimes hinder a long-term horizon (e.g., fair value acc.)

▪ AM incentives are often not designed to long-term horizon

▪ Quarterly reporting, benchmarks and credit ratings foster a short-term view

▪ Current measures to address the difficulties of SMEs to access finance may not be sufficient

▪ Further steps should include – developing venture capital, dedicated markets and networks for SMEs, new securitization instruments for SMEs, standards for credit-scoring assessments of SMEs, promoting other "non-traditional" sources of finance (e.g., leasing, supply-chain financing, crowd-funding, …)


BACKUP

42


GDP growth at real exchange rate by geography, 2010-25

1009

42

51

12410

7427

142

131

1336

2328

Emerging 440: 47 percent of global growth

37 12 88 42 2157 2736 6

SOURCE: McKinsey Global Institute Cityscope 2.0

1 Small cities and rural areas. 2 Other large cities not included in the City 600. 3 Includes cities from China (Hong Kong and Macau) and Taiwan.4 Includes cities from Afghanistan, Bangladesh, India, Pakistan, and Sri Lanka.5 Includes cities from Cambodia, Indonesia, Laos, Malaysia, Myanmar, P.N. Guinea, Philippines, Singapore, Thailand, Vietnam.Note: Numbers may not sum due to rounding.

The great rebalancing: 440 emerging cities (>2 million habitants) will capture ~50% of the world growth by 2025

100% = $50.2 trillion

Chinaregion3

SouthAsia4

South-eastAsia5

LatinAmerica

EasternEurope& CentralAsia

MiddleEast &NorthAfrica

SubSaharanAfrica

OtherEmergingregions

Totaldeve-lopingregions

UnitedStates& Canada

WesternEurope

North-EastAsia

Austral-Asia

Otherdevelopedregions

Globalgrowth

Asia

Number of cities in the City 600

Developed 160:17 percent of global growth

24250

Examples▪ Hangzhou▪ Ahmadabad▪ Cancun


Leverage

Capital reserves/total balance sheet%

5.10 6.42 7.43

SOURCE: ECB

2 4062 2961 783

+35%

Jul 2013Jul 2012Jan 2009

-7.8%

Jul 2013

32,380

Jul 2012

35,762

Jan 2009

34,932Jul 2013Jul 2012Jan 2009

€ billions

EU banks total balance sheet

EU banks capital & reserves

Under the pressure of the macro-economic landscape and regulatory framework, European banks have achieved fast adjustment to new ratios


Challenge n°1 - Disintermediation: In Europe the economy remains largely financed by bank loans vs. financial markets

29 30 30 29 28 27 26 26 28 29 31 33 34

39 39 40 38 38 40 41 42 45 39 36 36 33

100% =

Bookvalue of Equity

Bonds

Loans

2012

19

32

17

31

2010

17

33

16

31

2008

16

28

16

32

2006

14

33

13

33

2004

12

34

11

33

2002

10

30

10

32

2000

10

32

SOURCE: McKinsey Global Institute Financial Assets database; US Federal Reserve; CPAT; S&P; McKinsey Global Institute analysis; Eurostat; CPAT; S&P

8%

4%

-1%

0%

6% 9%

CAGR based on values

2007–12

Net interest impact on corporations

65 66 71 71 71 69 70 69 73 71 68 67 65

100% =

Bookvalue of Equity

Bonds

Loans

2012

10

26

10

10

24

9

2010

10

23

9

9

20

9

2008

9

208

9

23

7

2006

8

23

8

7

23

8

2004

6

21

9

6

20

9

2002

6

20

8

6

25

8

2000

6

27

7

7% 2%

3% 5%

6% 9%

2000-07

Total financing outstanding to EU non-financial corporationsPercentage, $ trillions

Total financing outstanding to US non-financial corporationsPercentage, $ trillions

McKinsey & Company |SOURCE: Haver Analytics; Bank for International Settlements; national central banks; McKinsey Global Institute

NOTE: Numbers may not sum due to rounding.1 Includes all loans and fixed-income securities. Excludes asset-backed securities and mortgage-backed securities.2 Q2 2013 data.

Total debt,1 Q1 2013% of GDP

Challenge n°2 - Deleveraging has become a challenge for many European countries

110

65

92

80

91

50

45

72

84

58

106

78

96

129

227

94

111

122

101

124

177

38

88

29

89

75Canada 28460 53

UnitedStates2 28579 39

Australia 28765 87

Germany 28958 85

SouthKorea

331115 94

Greece 34274 20

Italy 34683 94

France 359111 98

Portugal 384135 36

Spain 411129 91

UnitedKingdom2 49396 211

Japan2 511100 119

Ireland 790202 349

Nonfinancial corporations

Households

Financial institutions

Government


Challenge n°3 - All types of capital flows have declined since 2007, and cross-border lending accounts for two-thirds the totalChange in total cross-border capital flows, 2007–12$ trillion, constant 2012 exchange rates

SOURCE: IMF Balance of Payments; McKinsey Global Institute analysis

Note: Numbers may not sum due to rounding.1 Includes primarily loans, currency and deposits, as well as a small share of trade credit. Excludes operations of foreign affiliates.

2012

3.5

Loans and deposits1

5.0

1.9

3.2

Debt securities

1.6

0.41.2

Equity securities

0.4

0.3 0.1


0.8

0.10.7

2007

11.3

Rest of World

Western Europe and UK

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