It's hard not to feel depressed, and frankly worried, about the future of the financial services industry.

Report after report, expert after expert confirms what common sense tells us: Fundamental change must occur for financial firms to secure a profitable future.

"The large banks will need to rethink each business line, each product, each geography — everything. The strongest survivors will turn themselves inside out over the next five years."

I wrote that nearly two years ago. And what's happened since? Not enough.

To be sure, bank balance sheets are stronger, capital ratios are higher, problem loans have been whittled and marginal businesses are memories for many companies.

But revenues remain below pre-2007 levels, investors are discounting bank stocks and very few companies have found a sure path to sustainable growth.

What are bank CEOs waiting for? Economic recovery is not a sufficient answer. Hope is not a strategy. Change is coming and bankers have a choice — get in front of it or get left behind.

"We are running to keep in place," Toos Daruvala, a McKinsey & Co. director, says to describe the industry over the last few years. "We've just pushed out, if you will, the timeframe for when the industry gets to its 'new normal' and starts earning the returns that are more like the 10% to 12% that it is needed to earn the cost of capital."

With returns closer to 7% today, the industry has a long way to go.

Simplification is the key to what ails the largest banks. And while much of the Dodd-Frank Act may eventually force systemically significant banks to streamline themselves, it's a good bet the market will beat regulators to the punch.

"The largest, most diverse and most complex institutions … certainly will not get bigger. They may well get smaller," says Daruvala. "I suspect it will be less regulatory pressure and more investor pressure and performance pressure.

"There are only so many years when you can move along at 0.6 or 0.7 [times] price to book. I think we have another couple of years. The pendulum will hit the other extreme in two to three years, and if banks haven't solved their issues by then, I think there will be some further action by investors."

Put more bluntly: Shareholders will force divestitures or even break ups.

Banks that prefer more control over their destiny might want to read Daruvala's latest study. "The Triple Transformation" is McKinsey's latest attempt to grab bank executives by the lapels and get them to focus on the future.

According to McKinsey, the economics of everything a bank does needs to be rethought. Business models must be revamped. The culture has to change.

All three are equally important, but some banks need more work in one area versus another, Daruvala says.

Let's take them one by one.

First, the "economics of banking" comes down to deploying capital smarter and finding ways to build revenue.

"Banks need to take a much more granular look at what they are doing on the balance sheet, given capital ratings," Daruvala says. "Frankly, banks have to take off the rose-colored glasses and don't just hope that the ROE in a line of business is going to come back to what they used to be, but really look hard at what is the bank capable of achieving in that line of business."

On the revenue line, banks have to think about pricing and new pockets of growth.

"In a world in which you've got really compressed net interest margins, given the low-rate environment, you've got to be looking at fee income as alternative sources," Daruvala says. "I think this is really a conundrum. … What are you going to be able to do, given the regulatory reality and given the competitive reality, from a pricing and a fee-income standpoint?"

McKinsey says banks must get customers to pay for the products and services they value. One example might be online banking. It's widely free and yet it is clearly a product customers love.

"Are there other sources of value-added services that banks are providing that consumers would be willing to pay for in fully transparent, disclosed ways?" Daruvala asks. "I don't think banks have done that."

Daruvala offers up the airline industry as an example of the sort of wholesale change McKinsey thinks is necessary. "The way airlines price today is hugely different whether it's a fee for a second bag or extra legroom or an aisle seat."

Cost-cutting is the other side of that coin, and more of it is coming.

"We've clearly had important moves on the cost side, but I don't think we've seen structural cost transformation as yet in the banking industry," Daruvala says. "Those are the sorts of things we will see over the next three years."

He's talking about massive change along the lines of what's happened in both the auto and telecommunications industries.

In banking, the branch network is an obvious place to look for transformation. In the future, branches will be less about transactions and more about sales, service and advice. This is already happening but nowhere near fast enough.

"In the United States, we expect that by 2020 there will be only two-thirds of today's branches," the McKinsey study predicts.

The look, feel and purpose of branches will change and the people who work in them will need completely different training.

Technology is a big reason and a big opportunity to book efficiency gains and focus on sales and advice rather than cashing checks and accepting deposits.

"Are branches going away anytime soon? Heck no," says Daruvala. "But transactions will move online and branches look and feel very different with more skilled people capable of delivering advice when the consumer needs it."

No longer will branch staff simply sell the "product of the month." Instead they will use technology and customer data to customize product pitches. "There is a lot of runway for branches to be used like that," Daruvala says.

And yes, he's aware that banks have been talking about this for years. "All the banks talk about this idea, but the level of execution around both the quality of the technology and the models to identify the next-best product for that specific consumer and the capability and training they provide must be vastly different."

Let's move on to McKinsey's second area in need of transformation: business models. There's way more detail in the report than can be covered here but Daruvala predicts "massive simplification" among banks.

"In many banks there is enormous complexity. There is an enormous range of businesses … to the point where there really is [an incentive] to think about how do we run the place in a massively simplified, less bureaucratic way."

And this isn't just talk. "The larger, more complex institutions are absolutely trying to figure out ways to become more simple," Daruvala says. "They get the fact that they have gotten to the point where there are significant diseconomies from their size and diversity of businesses."

Finally, the McKinsey report tackles culture.

"Banks should take the time to examine their cultures carefully across four dimensions to ensure they are fostering value creation: balancing the interests of shareholders and society as a whole, creating value for customers, ensuring the soundness of internal processes and influencing the mindset of employees," according to the report. "Directors and senior managers should view cultural transformation as a strategic issue, not a public relations problem."


Bankers do get it, Daruvala says.

"They absolutely recognize there has been a breach of trust," he says. "I think they are struggling with how to deal with that, how to right the ship."

Barb Rehm is American Banker's editor at large. She welcomes feedback to her column Follow her on Twitter at @barbrehm.