world 2050 banking

8/9/2019 World 2050 Banking

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Financial Services

Banking in 2050:How big will the

emerging markets get?*


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The uture o Financial Services is a central theme being

addressed by the global fnancial services practice at

PricewaterhouseCoopers.1 In recent years we have

supported strategic thinking and thought leadership

such as Piecing the jigsaw: The uture o fnancial

services (published in 2005), which ocused on the

uture o the industry over the next three years,

considering the drivers, risks and opportunities, as well

as the impact on and responses o existing and potential

players in the industry. The report identifed fve principal

drivers that would aect all fnancial institutions:demographics, the economic cycle, politics, regulation

and reporting, and technology.

Continuing this uture perspective, the Economics practicein the UK member rm o PricewaterhouseCoopers hasdeveloped a series o research and thought leadershippapers ocused on the possible uture shape o the worldeconomy in the long run. The core o this research waspublished in 2006 in a report entitled The World in 2050,which provided a comparison o projected levels oeconomic growth in the G7 and the E7 over this period.

The overwhelming conclusion was that the economic worldorder will be very dierent or the next generation obusiness leaders (some o whom will come rom the E7nations) rom what we see today.

As an extension o the above, the UK member rm oPricewaterhouseCoopers, with input rom banking partnersaround our global network, has examined the possiblechanges in the scale o the banking sector between nowand 2050; our proxy was the relative growth o domesticcredit markets. The results are thought provoking; theyhighlight the pace o change and provide some scaleto the size o the opportunity and challenge. This paperhighlights some o these changes and we would encourageChie Executives and corporate strategy teams to considerthe possible implications or their business as well as thepossible strategic responses.

Overview

1 PricewaterhouseCoopers reers to the network o member rms o PricewaterhouseCoopersInternational Limited, each o which is a separate and independent legal entity.


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Banking in 2050: How big will the emerging markets get? PricewaterhouseCoopers

Executive Summary

In March 2006, we published a report highlighting the rapidgrowth and increasing global signicance o what we calledthe E7 emerging economies: China, India, Brazil, Russia,Mexico, Indonesia and Turkey. By 2050, we estimated thatthe E7 economies could be larger than the current G7 bybetween 25% and 75%, depending on the measure used.

In this new report, we show that the E7 economies are alsolikely to become increasingly signicant in the world obanking. Specically, our projections suggest that:

Over time, the banking sector is going to grow signicantlyaster than GDP in these emerging economies asthey develop;

In our main scenario, total domestic credit in the E7economies is likely to overtake total domestic creditin the G7 economies within the next 40 years;

Total domestic credit in China is likely to overtake theUK and Germany by 2010, Japan by around 2020 andthe US by 2045;

India is likely to emerge as the third largest domestic

banking market in the world by 2040 and could growaster than China in the long run;

Brazil, Indonesia, Mexico, Russia and Turkey all have thepotential to develop banking sectors o comparable scaleto major European economies such as France and Italybeore 2050;

Many E7 economies already have relatively protablebanking sectors, and our estimates suggest that total protsrom domestic banking in the E7 will be around hal thosein the G7 by 2025 and larger than in the G7 beore 2050;

M&A activity in the emerging market banking sectors islikely to show correspondingly strong growth over the nextew decades as domestic and international banks jockeyor prime position;

Restructuring o emerging market economies will give riseto many more opportunities or private equity rms; and

Banks rom emerging economies will start to make majoracquisitions in developed markets to gain better access tocapital markets and to acquire expertise and know-how.

In short, no bank can aord to ignore the E7 in its uturestrategy, but this also means that these markets willbe highly competitive. Adopting the right strategy andmaintaining a competitive edge in these emerging marketswill pose a major challenge or North American andEuropean banks seeking to make the most o these marketsand identiy the right local acquisition targets and strategicor joint venture partners.

Key questions arising

There are wide-ranging implications or banks rom ouranalysis. Amongst the questions or chie executives andcorporate strategy teams to consider are:

Does our banks near-term strategy encompass anadequate presence in emerging markets? I so, whendo we wish to enter or how should we expand ourexisting presence?

Can we aord to ignore emerging markets, or will ameaningul presence in selected emerging markets proveto be essential in the medium term to maintain corporateclient and investor interest in our institution?

In which market other than our own, i any, does, or could,our institution have a sustainable competitive advantage?

Should we enter by organic means or seek acquisitiontargets or venture partners? How do we justiy potentiallycostly investments in high-growth marketplaces? Whichsegments o the banking market provide the highestgrowth prospects in the major emerging markets?

When entering an emerging market, or expandingoperations there, what are the success actors that willmake our institution successul when competing with ast-

growing local competitors, who may have the advantageo a lower-cost operating model?


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2 Banking in 2050: How big will the emerging markets get? PricewaterhouseCoopers

In our March 2006 report2 on the state o the world in 2050,we estimated that by that date the E7 economies could belarger than the current G7 by between 25% and 75%depending on the measure used. In September 2006, wepublished a ollow-up report looking at the implications othis growth or global energy consumption, carbon emissionsand climate change policy. Now, in this third report, we turnour attention to the implications or banking: will China,India and other E7 economies also come to dominate thissector o the world economy?

To explore this question urther, we have extended ouroriginal GDP growth model to encompass banking assetsand prots, as outlined in Figure 1 below (urther technicaldetails are provided in the Annex).

GDP growth projections

The starting point or our analysis was a baseline projectionor GDP growth to 2050. As explained in the Annex, and inmore detail in our original report, these projections refectthe combined eect o projected working age populationgrowth (rom UN projections), investment rates, education

levels and trends, and the scope or emerging economies tocatch up with the global technological rontier. We also allowor likely real exchange rate increases over time in theemerging economies by distinguishing between real GDP

growth in domestic currency terms and in dollar terms.As illustrated in Figure 2 opposite, our baseline GDPprojections see growth being signicantly higher in the E7than the established developed economies, particularlywhen growth is measured in dollar terms to allow or risingreal exchange rates in the E7 (refecting strongerproductivity growth in these economies).

Interestingly, this analysis suggests that India is likely to bethe astest growing o the E7 economies in the long run. Our

model suggests that China will continue to grow somewhataster than India over the next 5-10 years but, ater that,Chinese growth will be held back by its rapidly ageingpopulation (due in large part to its one child policy) anddiminishing returns to its investment-led strategy. Incontrast, India and other emerging economies like Brazil,Mexico, Indonesia and Turkey have much youngerpopulations with aster-growing labour orces.

We can also combine our GDP projections with UNpopulation projections to derive GDP per capita projectionsin purchasing power parity (PPP) terms. The latter provide aconvenient summary measure o the state o development

o each o the economies, which in turn we nd to be a keydriver o the size, relative to GDP, o their banking sectors,as discussed urther below.

Note: all projections done by country then aggregated to global level

GDP model assumptions

Banking assets to

GDP ratio trend analysis

(charts)

Return on assets

trend analysis

Regression analysis

Expert judgement

GDP & GDP/capita projections

from PwC model to 2050

Banking assets projections

Banking profit projections

Figure Global banking projections model structure

Source: PricewaterhouseCoopers model using data rom IMF on banking assets and Fitch on prots

2 Available rom our website at http://www.pwc.com/world2050

Introduction


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Relationship between banking sector size and

economic development

It is a well-established act that, as an economy develops,

it moves rst rom specialising in agriculture to specialisingin manuacturing, and then rom manuacturing to services,including banking and other nancial services. All o the G7economies have been in this third stage o post-industrialdevelopment or at least the last 20-30 years, during whichtime there has been an underlying upward trend in their ratioo banking assets3 to GDP. The E7 economies have also seena clear upward trend in this ratio, albeit rom a much lowerbase and oten with considerable short-term variationsaround this underlying trend (see Figure 3).

Despite this upward trend, with the exception o China,

the E7 banking sectors are still relatively small in globalterms, as Figure 4 shows.

As their economic development continues, however, wewould expect the E7 banking (and other services) sectorsto grow more than proportionately with GDP. We can alsosee this rom the cross-sectional analysis o 2004 datashown in Figure 5 overlea, which illustrates a strongpositive relationship between domestic credit to GDP ratiosand GDP per capita levels.

*Includes projected real exchange rate appreciation (shown in light blue bars)

Japan

Germany

*% real GDP growth p.a.

UK

US

Russia

Mexico

Brazil

Turkey

Indonesia

China

India

0 2 4 6 8

Domestic currency US $ terms*

Figure 2 Projected average real GDP growth 2005-50

Source: PricewaterhouseCoopers baseline scenario projections

% of GDP

0

20

40

60

80

100

120

140

G7 average E7 average

53 57 61 65 69 73 77 81 85 93 97 01 0589

Figure Development o domestic credit to GDP ratio

Source: IMF/PricewaterhouseCoopers calculations

Japan

Germany

$ billion

UK

US

Russia

Mexico

Brazil

Turkey

Indonesia

China

Spain

ItalyFrance

Australia

Canada

India

Korea

Domestic credit: (Net) claims on central government +claims on state and local governments + claims onnon-financial public enterprises + claims on private sector+ claims on non-bank financial institutions

0 2,000 4,000 8,0006,000 10,000 12,000

Figure 4 Current size o banking sectors (2004)

Source: PricewaterhouseCoopers

3 Here and elsewhere in the report we use IMF data on total domestic credit as our measure obanking assets. This is to ensure a consistent approach across all countries, while we ocusonly on domestic credit since this is most likely to be related to GDP.


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Figure 5 also shows, however, that there are some notableoutliers, particular China, the UK and Spain, with muchlarger banking sectors than their state o economicdevelopment might suggest, and Russia, Mexico and theUS, with relative low ratios.

Figure 6 below summarises possible explanations or this inthe case o our o the key outliers (or Spain it is related tothe recent housing and mortgage boom, while or Mexico itis related to the relative lack o development o the retail

banking system, although this is now beginning to growrapidly so the ratio should rise in uture).

The reasons listed in Figure 6 are a combination o temporaryactors (e.g. cyclical housing booms) that may be reversedwithin 5-10 years and deeper structural actors (e.g. thestrength o US capital markets as an alternative to bank loans)that may persist or much longer. In our baseline scenariobelow, we assume that there is gradual convergence othese outliers with the average relationship between the sizeo the banking sector and economic development illustratedin Figure 5.4

JapanGermany

GDP per capita ($k1995 prices)

Domestic

bankcreditas%G

DP UK

Korea

Spain

Italy

Canada

AustraliaFrance

US

RussiaMexico

BrazilTurkey

Indonesia

China

India

0 5 10 15 20 30 35 4525 40 50

180

%

160

140

120

100

80

6040

20

0

Figure 5 Relationship between income and banking

penetration (2004)

Source: IMF

Relatively high degree of

non-performing loans (which

have been reduced in some

but not all banks)

Underdeveloped equity

markets (Hong Kong has

historically attracted large

share listings)

Historically, the state-owned

banks were encouraged to lend

(but are now being controlled)

Low interest rates

(but now rising)

High property ownership

High relative property prices,

funded by mortgages

Relatively few restrictions

on consumer credit

Major global financial centre

in London has attracted

inward investment inbanking sector

Fragmented banking sector

State regulation of banking

sector

Highly developed bond

and equity markets

Culture of equity finance

Mortgage securitisation

Heavy economic reliance

on energy and other natural

resources, with lower

borrowing requirement

Relatively low level of

commercial banking sector

development, with state

banks still dominant

Why is China so high? Why is the UK so high? Why is the US relatively low? Why is Russia relatively low?

Figure 6 Explaining the outliers


4 In practice, the analysis is somewhat more sophisticated than shown in Figure 5, asdescribed urther in the Annex, but the general idea is the same.


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Banking in 2050: How big will the emerging markets get? PricewaterhouseCoopers 5

Projecting orward domestic credit levels

Our baseline projections are thereore derived by assuming

an underlying upward trend in the domestic credit to GDPratio (subject to a maximum limit o 200% o GDP, the basisor which is discussed urther in the Annex), but then toallow or gradual convergence to the norm or outliers at arate o 2% per annum (or 3% per annum or China, wherethe initial divergence is largest, as is evident rom Figure 5opposite). The resulting projected domestic credit to GDPratios or the G7, the E7 and the world as a whole are shownin Figure 7.

We can see that, initially, the weight o the E7 in globalbanking assets is low (as shown in Figure 4 on page 3),so the global average is close to the G7 average. Overtime, however, the E7 ratio rises much aster than the G7ratio so that near convergence is achieved by 2050. Inabsolute terms, with total E7 GDP projected to be around25% higher in 2050 than G7 GDP by 2050, this impliesslightly higher total banking assets in the E7 than the G7 by2050 (see Figure 8). Even by 2025, E7 banking assets wouldhave reached just under hal o the G7 total, compared withless than 15% now.

Looking at the largest economies, our baseline projectionssuggest that China could overtake the UK and Germany by2010, Japan by 2025 and the US beore 2050 (Figure 9). Indiacould also rise rom relatively low levels today to having thethird largest banking sector in the world ater around 2040.

Domes

ticcredit($2004bn)

0

50,000

100,000

150,000

200,000

250,000

G7 E7 World

2004 2009 2014 2019 2024 2029 2034 2039 2044 2049

Figure 8 E7 vs G7 total domestic credit


Domesticcredit($2004bn)

0

10000

20000

30000

40000

50000

US China India

Japan Germany UK

2004 2009 2014 2019 2024 2029 2034 2039 2044 2049

Figure 9 The rise o the Asian giants


Domes

ticcreditas%G

DP

0

20

40

60

80

100

120

140

G7 average E7 average Global average

2004 2009 2014 2019 2024 2029 2034 2039 2044 2049

Figure 7 Projections or domestic credit to GDP ratio:

E7 vs G7 and global average



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As illustrated in Figure 10, other E7 banking sectors arenot going to rival those in China and India in terms o size,but they could come by 2050 to be o the same order omagnitude as the banking sectors in countries like Franceand Italy, rom much lower levels today. Brazil, Indonesia,Mexico and Turkey all seem to be strong candidates or arapid expansion o their banking sectors in the long run,driven by a rise in retail banking (mortgages, consumercredit and the like) that is already beginning to becomeapparent today but has much urther to go as their

economic development proceeds.

O course, any such individual country projections aresubject to many political, social and economic uncertaintiesthat could yet throw this projected strong growth o trackor prolonged periods. But, as a portolio, the E7 bankingmarkets appear to have strong potential, and we ound thiswas robust to an alternative scenario in which we did notassume convergence to the norm or the major outliers romFigure 5 on page 4 (see Figure 11). In this case too, the E7 isprojected to overtake the G7 beore 2050.

Japan

Germany

% of world total

UK

US

Russia

Mexico

Brazil

Turkey

Indonesia

China

Spain

Italy

France

Australia

Canada

India

Korea

0 5 10 15 20 25

2050 shares 2004 shares

Figure 0 Shits in shares o global banking assets


Dom

esticcredit($2004bn)

0

50,000

100,000

150,000

200,000

250,000

300,000

G7 E7 World

2004 2009 2014 2019 2024 2029 2034 2039 2044 2049

Figure Alternative scenario or domestic credit:

No convergence



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Banking profts pool projections

Projections o banking assets are all very well, but orpotential new entrants or acquirers in the emerging markets,it is the size o prots pools that matters most. To get someinsight into how these might develop, we carried out ananalysis o a large bank prots dataset rom Fitch. Focusingon the period since 2000 (or, in some cases, just the latestdata or 2005 where this seemed more reliable5), we oundpost-tax return on assets averaging around 1% globally butwith considerable variations by country, as indicated inFigure 12.

It is interesting to note that, with the exception o China,where protability has been held down by state banklending policies in the past (though it is starting to rise now),the emerging market banks actually appear to havesomewhat higher average protability than the banks inmost G7 countries (notably Germany and Japan, but alsoFrance and Italy to a lesser degree). O course, inter-countrycomparisons are subject to some qualications here due todierences in accounting standards and practices, so toomuch should not be made o the precise numbers in

Figure 12. At a minimum, however, there is no particular signrom this analysis that emerging market banks are lessprotable on average than those in the G7: rather thecontrary seems to be true on the whole.

Looking orward, we again consider two scenarios(which can be paired with the convergence/no convergencescenarios or domestic credit to GDP ratiosdescribed above):

Baseline scenario with gradual convergence (by 2030)o return on assets ratios in all countries to the globalaverage o 1%, driven perhaps by cross-border capitalfows tending to equalise returns across countries;

Alternative no convergence scenario in which the return

on asset ratios shown in Figure 12 persist.

Figure 13 shows our banking prots pool projections (ordomestic credit assets only) in these two scenarios or theG7 and the E7. Again we can see that the E7 rises to closeto hal o G7 prot levels by 2025 and to more than G7levels by 2050. The enormous increase in the relativesignicance o the E7 is again robust to the choice oconvergence assumption, although individual country protsprojections would be more sensitive to this assumption.

This is not to say that prots in the G7 stand still. On thecontrary, as Figure 13 shows, they are projected to rise by

around 300-400% in real terms by 2050, broadly in line withprojected G7 GDP growth over this period. But compared tothe growth rate o the E7 this is relatively modest.

Japan

Note: global average = c.1%

*Except for Russia, China, Germany and Japan, where 2005 data used

%

Germany

Post-tax return on assets (average for 2000-5*)

UK

US

Russia

Mexico

Brazil

Turkey

Indonesia

China

Spain

Italy

France

Australia

Canada

India

Korea

0.0 0.5 1.0 1.5 2.0

Figure 2 Banking return on assets ratios

Source: Fitch

5 In the light, or example, o banks in many emerging markets only moving relatively recently towards International Financial Reporting Standards, although this process remains incomplete, so thecomparison o returns in Figure 11 needs to be interpreted with appropriate caution.

0 200 400 600 800 1000

*Note that, without RoA convergence, E7 RoA remains higher than G7

Profits on domestic credit (constant 2004 $bn)

Baseline scenario with convergence

No convergence scenario*

E7

G7

E7

G7

2005 20502025

Figure Illustrative banking profts pool projections

Source: PricewaterhouseCoopers projections


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Possible strategic implications o the rise

o the E7 banking markets

The analysis above reinorces the signicance o China,India and the other E7 markets as by ar the greatestpotential growth areas in global banking in coming decades.This growth potential is illustrated by the numbers in Figure14 opposite, which also summarises recent trends and keymarket drivers or each o the E7 banking markets, ranked inorder o current size.

Retail banking sectors seem likely to see particularlyrapid growth, since mortgage and consumer credit lendingis generally not well developed yet in these markets comparedwith corporate and government lending (although boththese areas also oer considerable opportunities as well).

The rise o the E7 is likely to be associated both with rapidorganic growth o the key players in these banking markets,and with rapid increases in M&A activity, both within theE7 countries (due to consolidation o oten ragmentedbanking sectors at present), and across borders.

Restructuring o the E7 economies should also create majoropportunities or private equity frms. It is anticipated inthe short and medium term that private equity nance willbe able to participate through investment in the evolution obanking markets in the E7 countries, ahead o and alongsidedomestic and international banks.

For North American and European banks the analysis alsoemphasises the importance not just o being active in theE7 markets but also o having the right strategy in terms o:

choosing the right local targets or acquisitions, jointventures and strategic alliances;

understanding the preerences o local banking customersand the local competitive environment, so as to oer theright kind o product mix and pricing strategy; and

understanding the local legal and regulatory environmentand other relevant aspects o local custom and practice inthe banking sector.

At the same time, some o the major banks in China andother E7 countries are likely over the next 10-20 years tobecome signicant regional or global players throughoutward expansion by E7 banks, both organically and

through M&A. This will be driven by a number o actors,including:

the desire to access large developed markets;

the need or local branches to provide banking servicesto other E7 companies expanding into overseas markets;

the need to access capital; and

the need, at least in the short term, to access expertiseand know-how through acquisitions (e.g. in areas suchas wealth management, mortgages and credit cards).

E7 banks will also become major competitors in the

global war or talent. In act, we are already seeing signso this, with Russian banks hiring investment bankers romLondon, some Chinese banks importing US or Europeanexecutives, and Indian banks seeking to attract back stawith experience o working or major G7 institutions. As the

E7 banks internalise the knowledge o these sta, so theircompetitiveness in both domestic and global marketswill increase.

However, some major E7 banks may also come underoreign ownership, subject to domestic government policytowards such acquisitions.

In short, the banking world in 2050 will look radicallydierent rom the one we see today, with the E7 economiesbecoming at least as important as the G7.


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Figure 4 Key trends and prospects or E7 banking markets

Source: PwC, IMF data on domestic credit in 2004

Country Domestic creditin 2004 ($trillion)

Projected domesticcredit in 2050($trillion: at constant2004 prices)

Recent trends and key market drivers

China 2.8 45 Sale o major state banks with progress on reducingnon-perorming loans

Protability starting to rise rom low base

Large increase in oreign bank investment Rapid growth in retail banking rom low base, with huge potential

in mortgage and consumer credit markets as incomes rise

India 0.4 23 Major nancial sector reorms since 1991

Public sector banks still dominant but private/oreign banksgaining market share

Entry barriers being eased gradually but still signicant ororeign banks

Middle class growing strongly in cities

Brazil 0.3 8 More stable economy in recent years

High protability and automation in banking

Foreign banks entering via acquisition

Relatively underleveraged corporate sector

Mexico 0.2 6 Economy has stabilised recently ater nancial and banking criseso 1990s

Improved bank regulation and accounting standards, helped bysignicant entry o oreign banks

Low share o banking sector in GDP gives scope or strong uturegrowth i economic and political stability can be maintained

Russia 0.2 5 Largest two state banks still dominant; rest o banking sector quiteragmented

Regulatory regime has been weak with only gradual progress onbanking reorms

Heavy bank ocus on major cities

Buoyant energy sector, but economy needs to become morediversied in long run, including stronger banking sector

Turkey 0.2 4 Macroeconomic environment much improved since late 1990s(lower infation)

European banks increasing active in Turkey

New Banking Law strengthened banking supervision/regulation

Strong consumer lending growth potential

Indonesia 0.1 7 Still a relatively low income country but with good long-term scopeor growth i political situation remains relatively stable

Crisis o late-1990s stimulated banking reorm and restructuring

Growing oreign investment in domestic commercial banks andshit rom corporate to consumer lending since late 1990s

E7 total 4.2 98 High growth, with potential to mitigate high individual risks

through portolio approach

G7 total 30 83 Moderate growth but lower risk


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Long-term economic growth model

The model used to project long-term economic growth inthis paper is described in detail in our March 2006 paper,The World in 2050.6 The model is a standard one in theacademic research literature in which economic growthis driven by our main actors:

Technological progress, including catch-up eects oremerging economies that vary according to their stateo institutional development and stability;

Demographic change, in particular the growth rate oworking age population;

Investment in plant, machinery, buildings and otherphysical assets, which contribute to the long-termdevelopment o the capital stock in the economy; and

Trends in education levels, which are critical to the qualityo the labour orce and their ability to make the most onew technologies.

The assumptions used in this model refect a broad rangeo research by bodies such as the IMF and the World Bank,

as well as leading academic economists. While any suchassumptions are subject to many uncertainties, we believethat the baseline economic growth scenario used in thispaper, with average global economic growth o around 3.2%per annum in 2005-50, is plausible.

Exchange rate projections

Purchasing power parity (PPP) exchange rates7 areassumed to remain constant over time in real terms, whilemarket exchange rates converge gradually over time tothese levels in the very long term (due to aster productivitygrowth in the E7). This means that the relative value o E7banking markets in dollar terms tends to rise in the long rundue both to aster economic growth in these countries andto real exchange rate appreciation.

Banking assets data and projections

For banking assets, we used data on total domestic credit(to households, companies and government) since thisseemed most likely to be related to GDP. For consistency,data were taken rom the latest online version o the IMFsInternational Financial Statistics database.

As discussed in the main text and shown also in Figure 15below, we see a clear and statistically signicant positiverelationship between GDP per capita growth and the

average annual rise in the domestic credit to GDP ratio. Inother words, the aster an economy develops, the aster itsbanking sector grows relative to the economy as a whole.This relationship is measured using IMF data over severaldecades in most cases, which gives some reassurance inprojecting orward a broadly similar relationship in the longterm. In practice, o course, this will not be a smoothprocess: there will be economic and credit cycles o varyinglength and severity in all countries that we cannot hope topredict with any accuracy. We can, however, look throughthese short-to-medium-term cycles to identiy plausiblescenarios or the long-term underlying trend in banking

sector assets by country, and here we are more condentabout making projections based on the underlying trendsseen in the historic data. This is particularly true whenlooking at portolios o countries such as the E7, withinwhich individual country variations in the long-term healtho the banking sector should tend to cancel out over time.

Annex: Methodology and data

6 Available rom our website at http://www.pwc.com/world20507 Initial estimates o GDP at PPPs in 2004 were taken rom the World Bank (2005), updated in

some cases or more recent estimates (notably in the case o China, where historic GDP

estimates were revised up signicantly in December 2005).

Japan

Germany

Change in real GDP per capita (% pa)

Domesticbankcreditas%GDP

UK

Korea

Spain

Italy

Canada

Australia

France

US

RussiaMexico

Brazil Turkey

Indonesia

China

India

0 0.5-0.5 1.0-1.0 1.5-1.5 2.0 2.5 3.0 3.5 4.0 %

9

%

8

7

6

5

4

3

2

1

Figure 5 GDP growth and the banking sector



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We carried out a variety o statistical analyses o trendsin the banking assets to GDP ratio over time and acrosscountries, using GDP per capita levels as the key explanatoryvariable. For the purposes o providing a basis or utureprojections, we ound that simple cross-sectional relationshipso the kind shown in Figure 5 on page 4 tended to producemore plausible results than more sophisticated panel dataanalysis, which suered rom some econometric problemsdue to autocorrelation o residuals.

Ater some experimentation, a log-linear relationshipbetween domestic credit to GDP ratios in 2004 and GDP percapita levels in PPP terms provided the preerred basis orour projections model. This showed a highly statisticallysignicant (at the 99% condence level) positive relationshipbetween domestic credit to GDP ratios and GDP per capitalevels in PPP terms.

Given our projections or GDP per capita in PPP terms, wewere thereore able to project orward a target domesticcredit to GDP ratio or each country, with the exception othe US, where we used a country-specic time series trend.For the other countries, we then assumed in our baseline

scenario that their actual domestic credit to GDP ratiosconverged gradually to their target ratios, with 2% o thedierence being eliminated each year on this convergencepath. For China, we assumed a somewhat higherconvergence ratio o 3%, since there is evidence rom thepast couple o years that the ratio is likely to decline morerapidly in the short term due to past problems with non-perorming loans being corrected, although the ratio shouldthen rise again in the longer term as the retail lending marketin particular grows rapidly. We also considered a noconvergence, scenario where there was still an underlyingpositive relationship between domestic credit to GDP ratiosand GDP per capita, but no tendency or countries toconverge to their target ratios in the long run. In otherwords, in this scenario, outliers in Figure 5 remain outliers.

A maximum limit o domestic credit o 200% o GDP wasimposed in our model, based on experience in Switzerland(where the ratio appears to have topped out at around180% over the past decade) and analysis o minimumplausible interest cover ratios based on US and UK data.

Banking profts data and projections

Our data on banking prots were sourced rom Fitch andcovered the leading banks in each o the 17 countriesincluded in our model. We calculated weighted averagereturn on assets ratios or each country, as summarised orrecent years in Figure 11 in the main text above. We ocusedon recent years to reduce the impact o dierent accountingpractices across countries, although inevitably these remaina actor to some degree, particularly in the emergingeconomies.

These estimates then provided the basis or two illustrativescenarios or return on assets in the period to 2050:

Baseline scenario: linear convergence rom the return onassets ratios shown in Figure 11 on page 6 to a globalaverage return on assets o 1% rom 2030 onwards; thismight be taken to refect the impact o cross-bordercompetition and M&A in normalising prots across thebanking sectors o the major world economies; and

No convergence: return-on-assets ratios remain at thecountry-specic levels shown in Figure 11; this might

refect ongoing barriers to entry and structural dierencesacross markets.

In practice, many other scenarios are possible, o course,but ocusing on these two options denes a reasonablyplausible range. These return-on-assets scenarios werethen combined with our GDP growth and domestic creditto GDP ratio scenarios to produce two alternative scenariosor banking prots pools in the G7 and the E7 economies,as summarised in Figure 12 on page 7.


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Contacts

The authors o this report are John Hawksworth, Head o Macroeconomics, PricewaterhouseCoopers (UK) and Nick Page,Partner, Transaction Services Financial Services, PricewaterhouseCoopers (UK). Nick Forrest and Meirion Gyles oPricewaterhouseCoopers (UK) Economics practice, also made important contributions to the economic research underlyingthis report.

I you would like to discuss the issues raised in this report in more detail, please contact:

John Hawksworth

Head o MacroeconomicsPricewaterhouseCoopers (UK)

+44 20 7213 [email protected]

Nick Page

Partner, Transaction Services Financial ServicesPricewaterhouseCoopers (UK)+44 20 7213 [email protected]

Markus Burghardt

European Banking and Capital Markets Leader

PricewaterhouseCoopers (Germany)

+49 69 9585 2240

[email protected]

Javier Casas Rua

South America Financial Services Leader

PricewaterhouseCoopers (Argentina)

+54 1148504656.

[email protected].

Michael Codling

Banking & Capital Markets LeaderPricewaterhouseCoopers (Australia)

+612 8266 3034

[email protected]

John Hitchins

Partner, Banking and Capital MarketsPricewaterhouseCoopers (UK)+44 20 7804 [email protected]

Gordon Latimir

Financial Services Leader

PricewaterhouseCoopers (Russia)

+7 495 967 [email protected]

Dominic Nixon

Asia Financial Services Leader

PricewaterhouseCoopers (Singapore)

+65 6236 3188

[email protected]

Tom Pirolo

Global Banking & Capital Markets Leader

PricewaterhouseCoopers (USA)+1 646 471 [email protected]

Jairaj Purandare


PricewaterhouseCoopers (India)

+91 22 666 91400

Stuart Scoular


PricewaterhouseCoopers (Indonesia)+62 21 5289 1213

[email protected]

PwCs Economics practice oers a wide range o services covering competition and regulation issues, litigation support,bids and business cases, public policy and project appraisals, nancial economics, brand economics, the economics osustainability, business orecasting and macroeconomics. For more details o these services, please visit our website(www.pwc.com/uk/economics).


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The member rms o the PricewaterhouseCoopers network (www.pwc.com) provide industry-ocused assurance, tax and advisory services to buildpublic trust and enhance value or its clients and their stakeholders. More than 140,000 people in 149 countries share their thinking, experience andsolutions to develop resh perspectives and practical advice.

The PricewaterhouseCoopers Financial Services M&A suite o collateral is produced by experts in their particular eld at PricewaterhouseCoopers,to review important issues aecting the nancial services industry. It has been prepared or general guidance on matters o interest only, and is notintended to provide specic advice on any matter, nor is it intended to be comprehensive. No representation or warranty (express or implied) is givenas to the accuracy or completeness o the inormation contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopersrms do not accept or assume any liability, responsibility or duty o care or any consequences o you or anyone else acting, or reraining to act,in reliance on the inormation contained in this publication or or any decision based on it.

I specic advice is required, or i you wish to receive urther inormation on any matters reerred to in this paper, please speak with your usual contact

at PricewaterhouseCoopers or those listed in this publication.For urther inormation please contact ine Bryn, Marketing Director, Global Financial Services Marketing, PricewaterhouseCoopers LLP, London,on +44 20 7212 8839 or at [email protected]

For additional copies please contact Maya Bhatti at PricewaterhouseCoopers LLP, London, on +44 20 7213 2302 or at [email protected]

2007 PricewaterhouseCoopers. All rights reserved. PricewaterhouseCoopers reers to the network o member rms o PricewaterhouseCoopersInternational Limited, each o which is a separate and independent legal entity. Designed by studio ec4 18807 (05/07)

Subjects covered in the Financial Services M&A fyer series:

Entering the nancial services market in Taiwan

Entering the Gul nancial services market

Entering the Chinese investment management industry

European banking consolidation

Innovative nancing: Lie insurance securitisation

Russian Financial Services M&A

Further nancial services M&A related publications:

Financial Services M&A: Going or growth in Europe

Going or growth: the outlook or M&A in the nancialservices sector in Asia

Financial Services M&A: Review and outlook or mergersand acquisitions in the European nancial services market

The new deal: FS M&A in an IFRS environment

Focus on growth: Striking the right value balance withinnancial services

Focus on restructuring: the drivers shaping the nancialservices sector


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