PwC’s recent report, “Securing your tomorrow, today – The future of financial services,” predicted that alternative providers of capital are on track to become an even more important part of the global financial system, and that financial institutions are set for a once-in-a-generation change.

The changes include:

  • Accelerated digitization and real productivity gains required to survive restructuring wave
  • Zero interest rates re-define product and portfolio mixes
  • Capital constraints in regulated institutions drive financing to non-bank lenders
  • Post-recovery government actions drive ESG to the mainstream

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

In 2019, non-banks — including private equity funds and sovereign wealth funds — lent $41 trillion compared with the $38 trillion lent by traditional lenders. In particular, the analysis by PwC showed that private debt has experienced substantial growth, which is set to propel the asset class into a significant category of non-bank lending. Since 2010, CAGR in private debt has risen 11%.

For established financial institutions, the rise of alternative lending brings into question a bank’s role as a capital provider versus an intermediary, according to John Garvey, global financial services leader for PwC.

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

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

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

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