Islamic finance is today a $3.9 trillion industry spread over more than 80 countries with the bulk of it concentrated in very few markets. Comparing data from different sources shows that just 10 countries account for almost 95% of the world’s sharia compliant assets. Saudi Arabia and Iran lead the way with 25% to 30% market share each, followed by Malaysia (12%), the UAE (10%), Kuwait and Qatar (5.5%), Türkiye and Bahrain (3.5%), Indonesia and Pakistan (2%).

These countries drive the growth of Islamic finance, set industry standards and foster innovation. Over the past decade, Islamic finance grew at an exponential yearly pace of around 10%. According to the 2023 State of Global Islamic Economy report, total sharia-compliant assets will grow to $5.95 trillion by 2026 although that depends on the economic well-being of these 10 markets.

Islamic finance’s primary sphere of influence is of course the Arab world thanks to its Muslim-majority populations and abundance of petrodollars. The Middle East and North Africa (MENA, which excludes Iran) are home to over 190 Islamic banks.

The share of Islamic banking from total banking assets varies among Arab countries, with Sudan recording the highest share at 100%, followed by Saudi Arabia at 74.9%, Kuwait at 51%, Qatar at 28.6%, Djibouti at 25.0%, the UAE at 22.7%, Jordan at 17.8%, Palestine at 17.4%, Oman at 16.6%, and Bahrain at 16.1%.

The Gulf Cooperation Council (GCC) dominates the world of Islamic finance with over 97% of the top 50 Arab Islamic banks’ assets (see table below).

The region’s 15 largest Islamic banks are all GCC-based and accounted for nearly $770 billion assets in 2022. These banks sometimes branch out abroad—Bahrain’s Bank al Baraka for instance has offices in more than 15 countries. A milestone for the region was the finalization Kuwait Finance House’s acquisition of Bahrain’s Ahli United late 2022. The $8.8 billion created the second largest Islamic bank in the world with over $120 billion combined assets (see table below).

Up until recently, North African countries considered Islamic finance to be an unwelcome interference from Gulf states. Islamic banks and financial products were outlawed or strictly monitored.

Morocco allowed it last. In 2017, the regulator, Bank Al-Maghrib, allowed five Islamic banks to start operating in the kingdom. The country also issued its first Islamic bond or sukuk in 2018. By 2022, “participatory finance” as it is called there was worth $2.7 billion. Sharia-compliant lenders represented only 2% of the local banking market but their assets grew 20% year over year, a much higher growth rate than that of conventional banks.

That same year, Islamic lenders had a 5.1% market share in Tunisia and 2.4% in Algeria where Islamic banks already existed. Governments are currently working on legal frameworks to introduce sukuks and pushing for conventional banks to develop and commercialize sharia-compliant products.

Egypt, North Africa’s biggest market issued its first Islamic bond in 2023. Sharia-compliant finance grew 22% between 2022 and 2023 and represents about 4% of the local banking sector according to the Egyptian Islamic Finance Association.

If MENA represents Islamic finance’s past, the Asia-Pacific region—where the majority of the world’s more than 1 billion Muslims live—may represent its future.

Today, the Asian-Pacific region represents almost 25% of the global Islamic finance market. In Malaysia, sharia-compliant institutions account for close to one-quarter of the financial sector. Kuala Lumpur is one of the main drivers of the global sukuk market and weighs in on international compliance with the Islamic Financial Services Board, one of the world’s two major Islamic finance regulatory bodies.

Other mature Asian Islamic finance markets include Bangladesh, Brunei and Pakistan where sharia-compliant assets make up more than 15% of total bank assets.

Surprisingly, Islamic finance is still in its infancy in Indonesia even though its population is 90% Muslim. In 2023, sharia-compliant lenders accounted for only about 8% market share. In recent years, the authorities began to see the potential of Islamic finance and developed a roadmap to develop the sector with the help of Malaysian expertise that led to the consolidation of three entities to create of Bank Syariah, one of world’s ten biggest Islamic lenders. The country is also a pioneer for green Islamic bonds.

The nature of the African market—huge territories, little financial education, lack of regulatory frameworks—makes it challenging for Islamic banks to establish a presence in most Sub–Saharan countries. If sharia-complaint finance is to develop on the African continent, chances are will be led by banks from Egypt, Sudan and Morocco.

At this stage, Islamic finance in Africa tends to spread through private or sovereign bonds rather than brick-and-mortar banking. African governments see Islamic finance as a tool to raise development funds on international markets and diversify their pool of investors but so far, the results have been limited.

“We expect the top three sukuk issuers in Africa—South Africa, Egypt, and Nigeria—will continue to play a role in Islamic finance. Rated African sovereigns’ sukuk issuance amounts to almost $4.3 billion and has accounted for more than two-thirds of Africa’s total issuance of $6.6 billion since 2014” reports S&P in its 2024 assessment. However, “the complexities of sukuk and changes to sharia standards continue to intimidate African sovereign and slow adoption rates.”

In the aftermath of the 2008 crisis, Islamic finance appeared as a relatively safe alternative to the teetering Western banking system. Sukuks seemed like a good way to tap into new markets, Islamic funds represented opportunities to access large amounts of liquidity and Islamic banking was a way of monetizing local Muslim communities.

London positioned itself to become the hub for sharia-compliant finance in the Western world. Today, the UK boasts five licensed Islamic banks, over 20 conventional banks offering Islamic financial products.

Other European countries where Islamic finance made a remarkable start include:

France—which has the largest Muslim population in Europe—is also a promising market. Authorities (including France’s former minister of finance and IMF director Christine Lagarde) have pushed hard for the development of Islamic finance there, yet banks have largely failed to respond due to fears that being associated with Islam at a time when the country is targeted by terrorist attacks would damage their reputation. French investment banks however offer sharia-compliant products and services to cater to the needs of wealthy foreign clients. 

Russia has also started offering Islamic finance products through fintechs like Payzakat, or traditional banks. The idea is both to cater to its Muslim population and help its banks scale into MENA markets, like Sberbank the leading Russian lender who set up in Abu Dhabi in 2020.

Elsewhere in the world, some US banks have started offering sharia-compliant products but such offerings remain a very small niche. South America is the last continent where Islamic finance is taking root. Mexico is starting to think about it. In December 2017, Trustbank Amanah, the continent’s first Islamic bank, bank opened in Surinam.

In just a few decades, Islamic finance has established itself as a significant player in global finance. Today, with thousands of institutions around the world, this sector is no longer limited to the devout clientele of Muslim countries in the Middle East and Southeast Asia. It has successfully gained market share in Europe, Asia, Africa, and North America, where a diverse clientele is drawn to the Sharia-compliant principles of risk-sharing and social responsibility. As global investors increasingly prioritize sustainability and ethics, Islamic banking’s alignment with these values positions it as a key player in the burgeoning sustainable finance movement.

Islamic banking has also proven resilience in turbulent economic times. By prohibiting speculation and leveraging risk-sharing mechanisms, Islamic banks have demonstrated their ability to withstand crises, sometimes better than the conventional sector, a strength particularly relevant for investors in today’s uncertain economic climate. With a host of new financial innovations and robust regulatory backing, Islamic banking is poised for a bright future.

Islamic finance is a way of doing financial transactions and banking while respecting Islamic law or sharia. Islamic finance hardly existed 30 years ago yet today is a $3.96 trillion industry with over 1,650 specialized institutions located all around the world. Islamic banks are by far the biggest players in the Islamic finance industry and account for $2,7 trillion or 70% of total assets. According to a 2023 State of Global Islamic Economy report, total sharia-compliant assets are expected to grow to $5.95 trillion by 2026.

Islamic finance only represents about 1% of global financial assets but with a compound annual growth rate of 9%, it is expanding quicker than conventional finance. In some geographies like the Gulf Cooperation Council (GCC) or Sub-Saharan Africa, Islamic banks now compete directly with Western banks to attract Muslim clients.

So what is behind the success of Islamic finance? What makes Islamic finance special? Why is it growing rapidly?

All Islamic finance investments, acquisitions, and transactions must reflect Islamic values. Dealing with anything illicit (haram) like alcohol production, pork breeding, arms manufacturing, or gambling is strictly forbidden. It is interesting to note that similar initiatives exist in other faiths—the STOXX Index for example only selects companies that respect Christian values.

This ethically-driven approach to business partly explains the success of Islamic banks at a time when many customers lack trust in the financial system. Moreover, sharia-compliant entities have proven themselves in times of crisis.

Because Islamic law holds that making money from money is wrong, sharia-compliant institutions tend to refrain from engaging in speculation. They traditionally avoid derivative instruments such as futures or options and prefer to have assets grounded in the real economy.

This substantially protected Islamic banks from the 2008 financial crisis. Unlike their conventional counterparts, sharia-compliant banks were not involved with toxic assets and resisted the shock better.

“Adherence to Shariah principles—which precluded Islamic banks from financing or investing in the kind of instruments that have adversely affected their conventional competitors—helped contain the impact of the crisis on Islamic banks”concluded a 2010 IMF report.

This is a major reason why Islamic finance now has a serious, stable and trustworthy image around the world.

Many of the products offered by Islamic financial institutions are comparable to Western or conventional finance even though interest and speculation are forbidden. Banks are by far the biggest players in Islamic finance—some of them are exclusively Islamic while others offer sharia-compliant products but remain mostly conventional.

Aside from the absence of interest rates, the key concept of Islamic finance is risk sharing between parties in all operations. Here are some of the key sharia-compliant products offered by banks—they have Arabic names but in most cases we can find an equivalent in conventional Western banking.

Mudarabah or profit share: An investment in which the bank provides 100% of the capital intended for the creation of a business. The bank owns the commercial entity and the customer provides management and labor. They then share the profits according to a pre-established ratio that is usually close to 50/50. If the business fails, the bank bears all the financial losses unless it is proven that it was the customer’s fault.

Musharakah or joint venture: An investment involving two or more partners in which each partner brings in capital and management in exchange for a proportional share of the profits.

Takaful or insurance: Sharia-compliant insurance companies offer products comparable to conventional insurance companies and functions like a mutual fund. Instead of paying premiums, participants pool money together and agree to redistribute it to members in need according to pre-established contracts. The common pool of money is run by a fund manager.

The fund can be run in different ways when it comes to the surplus distribution and the fund manager’s compensation.

There are three big models:

In some cases, the fund manager creates a waqf, or a charity fund.

Sukuk or bonds: Sharia-compliant bonds began to be issued in the 2000s and standardized by the AAOIF—a Bahrain-based institution that promotes sharia-compliant regulation since 2003. Today, over 20 countries use this instrument. Malaysia is the biggest issuer, followed by Saudi Arabia and issuers outside the Muslim world include the UK, Hong Kong, and Luxembourg.

Sukuk issuance took off in 2006 when issuance hit $20 billion. Apart from a drop in 2015–2016 volumes then grew steadily to reach an all-time high of $162 billion in 2019, up 25% from 2018. This record number was backed by strong appetite from Malaysia, Indonesia, Gulf Cooperation Council (GCC) countries and Turkey.

That was before COVID 19. According to credit ratings agency Standard & Poor (S&P), the volume of issuance should drop around $100 billion.

“The market was, in fact, poised for good performance in 2020 but the pandemic and lower oil prices changed the outlook. Amid tougher conditions, we also don’t see core Islamic finance countries using sukuk as a primary source of funding despite their higher financing needs,” says S&P in its 2020 report on Islamic Finance.

Other industry experts beg to differ. Refinitiv research says sukuk issuances will continue to grow and could reach $174 billion in 2020 backed by government funding requirements.

Like conventional bonds, sukuks are very appealing to governments for raising money to spend on development projects. Their main challenge remains standardisation; buyers tend to find it more difficult to assess risk than with regular bonds.

Islamic finance also exists in the form of investment funds.

For hundreds of years, there was no need for Islamic finance because there was simply no financial system to “Islamise.” Up until the second half of the 19th century, the vast majority of the Muslim population around the world was unbanked and the prohibition of interest was applied on transactions by tradition rather than by law or regulatory bodies.

During the colonial era, Western banks and financial institutions penetrated Muslim countries and imposed interest-based methods on the Islamic world. In the 1940s and 1950s, independence movements pushed for the revival of Islamic culture and religious scholars in countries such as India, Pakistan and Egypt started to condemn the use of interest by banks. They proposed to prohibit interest and replace it with Islamic risk-sharing. Localized Islamic finance experiments took place in the 1960s in Egypt and Malaysia.

In many ways, Islamic finance was born as a rebellion against colonialism and for self-determination. The idea was to provide an ethical alternative to the Western-dominated international financial system based on the Quran.

In the 1970s, Persian Gulf countries—which were both suddenly incredibly rich with petro-dollars and extremely conservative in religious belief—took Islamic finance beyond local experiments and created the Saudi Arabia-based Islamic Development Bank in 1975 followed by the Dubai Islamic Bank in 1979. Because the establishment of the first sharia-compliant institutions coincided with the rapid economic development of their home countries, a large share of Islamic investments went into the construction and real estate sectors.

Islamic finance expanded quickly, first in the Arab world and East Asian countries with significant Muslim populations before reaching the West and especially the UK in the early 2000s. In parallel to that expansion, two regulating bodies emerged—the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) in Algeria (now relocated to Bahrain) and the Islamic Financial Services Board (IFSB) in Malaysia.

Today, there are over 1,650 Islamic financial institutions spread all over the world and total sharia-compliant assets represent $3.9 trillion. Although Islamic finance is less than 1% of the global financial market, it is one of the fastest-growing segments, attracting at times non-Muslim customers. While consolidating their existing markets, sharia-compliant entities have started to branch out into new territories, notably Sub-Saharan Africa and Europe. In a world that increasingly worries about environmental, social and governance issues, some depositors and investors see Islamic finance as an ethical way of dealing with their money.

Islamic finance offers products and services that comply with Islamic law (sharia) but who decides what is and is not sharia-compliant and what mechanisms exist to enforce those judgments?

Each Islamic finance institution has a sharia supervisory board (SSB). The board is composed of at least three jurists. They are paid by the bank but act as independent consultants. Their role is both consultative and regulatory: They answer the staff’s questions, advise on charity contributions (zakat), verify operations and certify products.

SSBs decide what is allowed (halal) or forbidden (haram) based on the two main sources of Islamic law: the Quran and the Sunnah—or what the Prophet Muhammad reportedly said and did during his lifetime. Board decisions are taken by majority vote and binding on the bank.

SSB members are typically religious scholars who specialize in Islamic jurisprudence. In Western countries like the UK, they can also be non-Muslims experts who have studied such matters extensively.

Over the past 10 years, Islamic finance has rapidly expanded across the world and finding qualified people to sit on SSBs has become challenging. In the world of Islamic finance, reputation is key and sharia non-compliance can be fatal to a bank.

At there international level, there are two supervisory bodies for Islamic finance: the Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) and the Malaysian Islamic Financial Services Board (IFSB).

These bodies collaborate with institutions such as the IMF or the World Bank to promote sharia compliance globally. The AAOIFI sets basic standards for the Islamic finance industry while the IFSB issues recommendations based on risk assessments.

In Bahrain and the United Arab Emirates, AAOIFI standards are mandatory but in most countries their standards and recommendations are not binding. If a bank doesn’t comply, there are no sanctions. It is up to each country’s government to enforce certain rules through their central banks who impose those rules on sharia boards.

In all countries—except Sudan and Iran—Islamic finance exists alongside conventional banking. For Islamic banks, this means navigating a dual regulatory framework: the country’s laws and regulations as well as sharia compliance.

“We’re more a network that enables various fintech to introduce new products into the market within the context of local regulations,” Mastercard’s country manager for Barbados, Jamaica, Trinidad & Tobago and the Eastern Caribbean, Dalton Fowles, told the Trinidad and Tobago’s Daily Express.

Fowles cited the example of digital payments for small and midsize businesses, especially local mom-and-pop shops. He said tap-to-pay options will appear in the region soon.

Helping those small businesses can be a boon for the broader economy. The Caribbean Development Bank reports that micro, small and midsize enterprises (MSMEs) account for around 50% of regional jobs and 60% to 70% of GDP.

The region’s unbanked are another prime target of fintech solutions. According to the National Financial Literacy Programme, an estimated 19% of the population in Trinidad and Tobago were unbanked in 2022. In Jamaica, this rises to about 22%, stated the Bank of Jamaica in its 2024 National Financial Inclusion Report. Some estimates put the number of unbanked in the Caribbean at two-thirds of its 45 million inhabitants.

Last year saw the launch of the Caribbean Fintech Sprint for Financial Inclusion, an open call for solutions to regional financial issues backed by the European Union and the United Nations Capital Development Fund. The winners were Unqueue and MLajan Mobile Wallet. Unqueue helps smallholder farmers access markets, while MLajan Mobile Wallet provides digital financial services in Dominica.

A Mastercard white paper released in March 2024 relating to remittances, or cross-border payments, highlighted digital offerings to cash environments, transaction transparency and safety, regulatory compliance, convenience, and value as critical to potential products and services. Mastercard studies have found that some Caribbean markets have 30% to 45% of their GDP in cash, which Fowles believes is ripe to be digitized.        

“The biggest challenge we have in Africa as oil-producing countries is funding, so a short while ago, the council held a meeting and said the solution was the Energy Bank,” Nigeria’s minister of state for petroleum (oil), Heineken Lokpobiri, said at the July APPO meeting in Abuja.

Afreximbank and the African Energy Foundation are also contributing funding. Yet whether AEB’s capitalization is enough to bridge the industry’s funding gap remains to be seen.

“AEB is a wonderful idea, but as with everything African, it will face some challenges, even if they are just teething problems,” says Marcel Okeke, a former chief economist of Zenith Bank.

He wonders where the AEB would find additional capital if needed. Okeke suggests that it could force the bank to approach non-African investors, perhaps in the form of the African Development Bank, which has non-African members.

Investors consider several factors, including safety and macroeconomic challenges, before deciding where to invest. In Nigeria, investment in the oil and gas industry took a steep dive from 2014 to 2022, from $27 billion to $6 billion, the Nigerian Upstream Petroleum Regulatory Commission said last year.

Some international oil companies have left the country, citing a tough business environment and economic insecurity. “Insecurity in Nigeria is chasing investors away, and the oil and gas industry has become inclement,” says Okeke, who added that this is happening in other African countries, too.

He also notes that the world is going through an energy transition whereby hydrocarbon alternatives are rising in popularity. At the same time, oil and gas have become political hot potatoes, which doesn’t favor the bank. “This is why alternative energy could become the focus of the energy market, rather than fossil fuel. Therefore, the reality is that those who would have cooperated with the bank may not,” says Okeke.

Once upon a time, banking was simple: Take deposits, use depositors’ money to make loans, and transfer payments between clients and earn a commission.

All three pillars are now under assault.

Longer-term savings have migrated to wealth managers who promise much better returns over time. An array of innovative fintechs offer alternatives for payments. Home or car buyers are ever more likely to borrow from nonbank originators. Some 70% of residential mortgages in the US, the world’s largest banking market, are processed by nonbanks, according to Brian Graham, partner at the Klaros Group, which advises and invests in financial firms.

Corporate borrowers have been shifting to nonbank lending since the 2008 global financial crisis, the latest hot alternatives being collateralized loan obligations and private credit. The latter has mushroomed to $2.1 trillion globally and is still growing fast. Nonbank financial institutions, or NBFIs, hold two-thirds of financial assets in the most advanced economies, according to the Financial Stability Board (FSB).

In order for the banking sector to regain market share from nonbanks, banks will need to change how they compete for customers. Long-established banks will need to become less cautious and more agile in navigating regulations. One avenue for the banking sector is to start from scratch, as KakaoBank did in South Korea and Nubank in Brazil.

Higher interest rates have given banks some relief over the past few years, increasing their net interest income while hampering competitors—particularly fintech startups dependent on equity financing. The FSB reported that global NBFI assets shrank 5.5% in 2022, the first notable decrease since 2009, while banks’ balance sheets grew by 6.9%.

Long-term trends remain adverse, though. “Banks are losing market share to nonbanks, and the situation is much worse than what the statistics show,” says Miklós Gábor Dietz, lead of McKinsey’s Global Banking Strategy and Innovation team, the global Ecosystems Hub and is the managing partner of Vancouver Office.

Banks are competing with the equivalent of weights tied to their ankles. These, of course, are the extra regulations and capital requirements most countries have piled on since the 2008 crisis. Any new loan needs to be risk-weighted and have capital set aside to offset it, restraints that nonbank lenders can often ignore.

Even as earnings seem to be healthy, banks struggle to earn a return on all that capital, Dietz points out—particularly on corporate lending. “On paper, this is the most profitable business in the world,” he says. “But on average globally, corporate banking is adding no value.”

Banks’ long histories and diverse business lines leave them lagging behind newer, more-focused rivals, as competition increasingly revolves around technology, adds Steven Breeden, American financial services technology lead at Bain & Company. “Banks are struggling with historical complexity traps and breaking through silos,” he says. “There’s a cohort of 10 or so banks globally that really get it on tech transformation.”

Yet banks get one large advantage in exchange for the regulators’ heavy hand: state-guaranteed deposits, a cheaper and (usually) more stable source of funding than nonbank rivals can tap.

History and the capacity for a wide range of transactions also have their pluses. “Banks inject trust into the financial system,” says Sandeep Vishnu, a partner at industry consultant Capco. “They are continuing to lose market share, but any complex transaction requires banks to play a role.”

Increasingly, that role is to “run in the background,” and have deep pockets on call, while more-dynamic actors close the deal directly with borrowers or merchants. Rocket Mortgage or another US originator may find the home-buying customer; the loan will likely be packaged into a mortgage-backed security and bought by a bank. At the corporate level, a private credit or leveraged-loan syndicate will likely secure bank credit lines as an anchor.

That’s risky for the financial system, says Viral Acharya, a professor at New York University’s Stern School of Business who specializes in financial regulation. “The growth of nonbanks is really coming on the back of liquidity from the largest banks,” he explains. “The cynical view is that everyone wants to have a put from the banking system in an emergency.”

Running in the background is not a great strategic position for banks either, McKinsey’s Dietz adds. The customer-facing entity gets a free ride, so to speak, on the bank’s capital base, and reaps consumer data that may be more valuable than the transaction itself.

The classic example in developed markets is the relationship between credit card provider Visa and the numerous banks that underwrite its plastic. Equity investors value Visa at 29 times earnings and 13 times book value, according to Bloomberg. The equivalent numbers for JPMorgan Chase, the world’s most profitable bank, are 12 and 2.3. “Banks haven’t solved their fundamental problem, which is losing customer ownership,” Dietz concludes.

The outlook for traditional banks is not all so bleak, particularly in emerging markets. Nonbank competitors are less developed there, leaving banks in control of 57.9% of financial assets, the FSB reports.

The megatrend of unbanked populations joining the financial system via cellular connection may enhance, not threaten, banks’ dominance. India is the prime example. Narendra Modi’s government requires the mobile payments systems that have mushroomed over the past decade are overwhelmingly linked to banks, Vishnu says. The result: 400 million new bank accounts.

Banking systems in middle-income emerging markets tend to be younger, with less “sticky” customer loyalty than in North America or Western Europe, leading to hotter competition and more innovation that crowds out nonbank startups. “The most innovative banks in the world, aside from India, are in Turkey or Poland,” Dietz asserts. “They are leapfrogging with more digital, more automated services.”

Elsewhere, online-only “digital-attacker banks” are shaking up the landscape, Bain’s Breeden says. The biggest player in this category is probably Nubank, based in Brazil and expanding aggressively into Mexico and Colombia. Founded in 2013, it exploded from 25 million customers in 2020 to more than 100 million earlier this year, focusing on credit cards and personal loans for retail customers.

In South Korea, online-only KakaoBank has grown from a standing start in 2016 to more than 23 million customers in a nation of just under 52 million. Attacking a highly mature banking market, the bank found a niche as the go-to institution for refinancing mortgages. It’s now eyeing expansion into Thailand in partnership with brick-and-mortar incumbent Siam Commercial Bank.

Unlike many fintechs around the world, Nubank and KakaoBank are also making money. Nubank’s net profit hit $1 billion for 2023, and KakaoBank earned about $267 million.

One more innovative champion hails from the unlikely location of Kazakhstan. Kaspi, one of the biggest e-commerce platforms in the oil-rich ex-Soviet nation of nearly 20 million, used its customer reach to start Kaspi Bank, with dramatic results. “Their return on equity is 90% instead of the 10% that’s standard,” Dietz notes.

Regulation has stymied similar vertical integration in bigger markets. Chinese authorities famously curtailed Ant Financial, sister organization to e-commerce power Alibaba, a few years ago. That has left most lending in the world’s No. 2 economy to very traditional state-owned banks.

Globally, much-anticipated financial services competition from online giants like Amazon, Meta, and Google has largely failed to materialize—largely because they would have to obtain banking licenses in the process. “Big tech has been making some surgical moves, mostly in the realm of payments and digital wallets,” Breeden says. “They are reluctant to set up fully fledged banks from a risk-compliance perspective.”

In the developed world, the banking establishment also has tools to fight back against nonbank competitors, if it can shake off some rust and unleash those tools. The spread of digital payments systems actually represents an opportunity for banks, Capco’s Vishnu says. They can negotiate better fee splits with these new entrants than with incumbent credit card providers like Visa. This would bolster a key income source for banks in the US and Western Europe. “Digital is now disintermediating the credit cards,” he notes.

Banks still retain considerable “customer ownership,” and of course trust, as the holders of deposit guarantees. The banks can possibly build on these factors to expand services instead of retreating.

One obvious area would be shifting more depositors into asset management, selling the convenience of keeping various forms of wealth under one roof. While larger banks are already doing this, they could do it more effectively. “Banks are seeing a lot of stress on net interest and fee income,” Vishnu says. “Capturing some of the wealth management that’s going outside banking could counteract that.”

Though banks in the US have access to the huge money pool, only two of the top-10 US asset managers are banks: JPMorgan Chase and BNY. And they are dwarfed by nonbank giants like BlackRock, Vanguard Group, and Fidelity Investments. European banks are more competitive in this area, accounting for three of the top-five asset managers on the Continent: Credit Agricole, UBS Group, and Deutsche Bank.

Dietz, at McKinsey, sees much broader possibilities for banks that can “organize themselves around customer needs,” creating and dominating new financial services verticals. For instance, one-stop shopping for home acquisition and ownership: combining brokerage, mortgage, and insurance in a single app. Or offering, as financial services firms do, “an adviser who knows everything about you”: wealth management, estate planning, tax and legal services bound together—a service like a private bank for the nonrich.

Breaking out these core functions into separate units would also bring universal banks some of the focus and maneuverability of “pure play” disrupters, while maintaining the strength and breadth of a larger organization, suggests Dietz.

“Unbundling the business and expanding into some nonbank areas are the two things that banks can do to escape the value trap they are in,” he says. “If they do, the opportunity is tremendous.”

One big obstacle to this transformation is psychological. Since 2008, many developed-world banks have hunkered down in a defensive crouch, focused on building buffers to avoid the near-death experiences of that time and complying with the onslaught of new regulation. Going on the offensive into new business lines has seeped out of their DNA. “Banks need to start erring on the side of maximizing their reach [and] not worry so much about losses,” Capco’s Vishnu says.

Another hurdle is technological. To leap to the kind of one-stop shopping Dietz envisions, banks will need software that works as simply and intuitively as that of digital-native pioneers like Uber or Airbnb. “Banks need to step up their game on human-centered design,” says Bain’s Breeden.

Among banks in the developed world, big US institutions look the best prepared for ongoing shifts in the financial landscape. They are ahead of the pack technologically, Breeden observes. “A handful of banks in the US Tier 1 rise above all others in being tech forward,” he affirms.

The top US players can also take advantage of weakness further down in the country’s archipelago of over 4,500 licensed banks, Klaros’ Graham says. Washington regulators contained the fallout when three second-tier banks—Silicon Valley Bank, Signature Bank, and First Republic Bank—abruptly failed last year. But many others continue to struggle with their key weakness: unrecorded losses on bonds bought when interest rates were much lower. Mounting liabilities from commercial real estate loans are compounding the problem.

A large amount of the US banking system’s reserve capital is “impaired,” Graham states. The concealed weakness is not dire enough to trigger a 2008-style wave of insolvencies, adds Graham, but it is enough to spawn an army of “zombie banks” that have reined in lending to conserve capital. Either they will yield clients or they’ll have to be acquired by stronger rivals. “This is an incredibly target-rich environment for banks that can afford to play offense,” Graham says. “They can acquire teams or grow loans.”

Like death and taxes, highly regulated banks holding state-guaranteed deposits are embedded as a fact of life in complex economies. “There is no alternative to banking as an ecosystem,” says Vishnu.

Also, like death and taxes, potential clients and customers increasingly avoid banks to the extent they can. For banks, there is no time to lose in reversing that trend.

The announcements in June by Japan’s three megabanks that they will sell $5.4 billion of their strategic cross-shareholdings over three years mark a milestone in the decades-long effort to remodel Japanese corporate governance along more investor-friendly lines.

Mitsubishi UFJ Financial Group said it plans to sell $2.2 billion of cross-shareholdings by the end of March 2027, Mizuho Financial Group expects to sell $1.9 billion over the next three years, and Sumitomo Mitsui Financial Group expects to divest more than $1.3 billion by March 2025. Significantly, Mizuho CEO Masahiro Kihara said the bank will either pass on the proceeds from its sales of equity holdings to investors as dividends or invest them in growth-directed activities, and Sumitomo Mitsui aims to reduce the market value of its equity holdings to less than 20% of the value of its consolidated net assets.

The megabanks’ announcement represent a milestone because Japanese banks have been one of the heaviest holders of strategic shares, dating from the decades following World War II, and among the most reluctant to wind them down says Haonan Wu, manager of engagement, EOS at Federated Hermes, a provider of stewardship services to investors on elections, obligations, and standards.

As such, the big banks’ pledges suggest that Japanese business is taking the need for change seriously, Wu says. “We’ve been discussing this for a number of years, holding meetings with the banks’ board of directors.”

The three big banks are not the only major Japanese companies pledging to reduce cross-shareholdings, which are strategic stakes that companies hold in their closest business partners, including suppliers and corporate customers. In May, some 70% of the companies listed in the Tokyo Stock Exchange’s (TSE) Prime market of large, global stocks said they would be selling off cross-shareholdings. And efforts by regulators to encourage the phase-out go back at least 20 years; average holdings of strategic shares by companies in the TOPIX 500 index dropped from 13.5% of new assets in 2015 to 8.4% in 2023. But the pace has been slower than this suggests; as of last year, 320 companies or 64% of the TOPIX still had more than 10% of their net asset value tied up in strategic shareholdings.

Traditionally, cross-shareholdings were seen to cement close, long-term relationships with counterparties as well as to assure management of a reliably loyal block of voting shares. However, a growing chorus of investors—especially those based overseas—have criticized the practice as an inefficient use of capital as well as a questionable corporate governance practice, since companies’ independent directors often represent strategic partners.

Institutional Shareholders Services (ISS) and Glass Lewis, the two big US proxy advisors, have been vocal on the issue. And in May, the Asian Corporate Governance Association—which includes Black Rock, Fidelity, and Federated Hermes—published an open letter calling on Japanese companies to “accelerate the further reduction of these shareholdings, which we believe in principle should be zero for most companies.”

In past years, such admonitions might have had less impact, but times appear to be changing. With the Japanese economy sluggish, Wu points out, the TSE has become concerned about the low price-to-book ratios of its listed companies, including banks; half of Prime members traded below book last year. The bourse now requires companies trading at less than a one-to-one price-to-book ratio to disclose their policies and initiatives for improvement and advised them to focus more on capital efficiency: for example, by reducing cross-shareholdings.

Japanese companies appear to be responding. Jun Frank, global head of governance and compensation at ISS-Corporate, notes that share buybacks—traditionally not a common practice—are up.

“Japanese companies historically have held onto cash rather than doing buybacks or paying out dividends,” he says, “so a lot of companies have a large stockpile of cash on their books. Now they’re thinking more strategically about how to allocate capital.”

Additionally, with Japanese stocks outperforming the Standard & Poor’s 500 for more than a year—the Nikkei index reached its highest level in 33 years in May—now would seem like a good time for companies there to unwind their strategic portfolios. Japanese investment firm Keystone Partners announced in March that it was setting up a $636 million fund to buy divested cross-shareholdings.

There’s no knowing for sure how far divestment will go; in March, Japan’s Financial Services Agency noted that some companies, which are now required to list their top 60 strategic shareholdings, may be engaged in “shareholding washing”: getting around the rule by claiming to own them only for trading purposes.

But if divestments do accelerate, Frank foresees a profound change in how Japan’s traditionally insular corporate boards behave. Fewer cross-shareholdings will “increasingly lead to greater board independence,” he says, the odds that activist shareholders can make themselves heard will improve, and “that will encourage companies to be more efficient in how they allocate their capital.”