Winds of change
Category: Asia, Europe
By Paul Mackintosh
Private banking heading for almost inevitable consolidation
Private banking is a sector whose own crisis, after some relatively mild early years, now seems to be prolonging and extending itself into new and worrying territory. Whether or not the entire industry faces an existential crisis, many of its leading practitioners certainly do.
“Five years on, the global economy still finds itself high on the drug of easy money,” says Gary Dugan, CIO for Asia and the Middle East at Coutts, following the fifth anniversary of the Lehman Brothers collapse. And, in concert with this view, Prince Max von und zu Liechtenstein, CEO of LGT Group, comments on “a profound uncertainty on the part of bank clients, a loss of confidence in the stability of the financial system” at the start of his company’s LGT Private Banking Asia Report 2012/2013. This was the mood in 2010, but, he adds: “The underlying situation facing investors remains just as difficult.”
Interestingly, however, the problems facing private banking are not necessarily about macroeconomic crises, or even regulatory pressure. “The shock waves roiling private banking are in no way entirely external in nature”, claims the 2012 Newtone Associates/A.T. Kearney poll of top private bankers in Europe and Asia, Private Banking in the New Era. “They have, in fact, been created by the industry itself”.
“The traditional value proposition for most private banks is indeed fading”, confirms McKinsey in its Global Private Banking Survey for 2013. The PricewaterhouseCoopers (PwC) 2013 Global Private Banking and Wealth Management Survey echoes the same premise: that trusted adviser status has not been fully restored and culture and ethics have now come to the forefront of the trust agenda. While the mechanics and systems of private wealth management still “need to be addressed”, PwC’s analysis continues, “in our view, achieving excellence in client experience and executing effective transformational change now need to be the priority areas of focus for the industry”.
And unfortunately for private banking, this reputational challenge has come to a head at a time when a structural change cycle has still not run its course – at least according to PwC. “The industry is part way through its transformation and, in many areas, our respondents appear to have underestimated the level of change required to meet existing operational challenges. It is understandable that transformation programmes are proving to be challenging in light of the sheer scale and breadth of the task at hand and the costs involved. But industry players will need to do more across the spectrum of their business and operating models than has been the case to date”.
“Structural changes in the industry will shape a new way of banking for private clients”, says McKinsey. “Consequently, private banks have no choice but to develop much more tailored value propositions to serve existing clients and attract new ones. Economic change will force private banks to adapt more comprehensively than most have done until now”. And some concerned observers, especially among Asia’s entrepreneurial high net worth (HNW) customer base, might legitimately ask if an industry that is so slow and reluctant to embrace change really has what it takes to spot and seize the best wealth-enhancing opportunities for its clients. There are obvious concerns about an industry, which McKinsey feels it is necessary to recommend that players must “protect the economics by running private banking as a real business”.
“Tough decisions have to be made, and since all the factors are tightly interlinked they should be improved or changed coherently”, cautions the Newtone Associates/A.T. Kearney report. But at the same time this survey offers grounds for hope. “Although the situation appears grim, there is tremendous opportunity to enforce a virtuous circle and get the industry (back) on the right track”.
The penalties for failing to embrace these challenges, however, are stark – and very much more than merely theoretical or pending. The mid-2013 report on private banking from the University of St. Gallen and KPMG concluded that 25-30% of Swiss private banks will close or merge within the next three years alone, with entities with under US$5 billion in AUM being especially vulnerable. And, PwC warns, “Singapore is closing the gap on Switzerland as an international financial centre for private client assets”.
One of the key structural developments going on in the industry right now is, of course, the rollout in Asia – or in some cases, rollback, as Western banks overextended pre-crisis retreat in less favourable market conditions. But all the same, Asia is a regional opportunity that market participants cannot afford to ignore. “Wealth management market growth varies tremendously by geography and this multi-speed market place is here to stay”, the PwC report contends. “Newly emerging markets are showing the highest forecasts of net new money growth”. McKinsey finds “profit margins up for the first time since the crisis” for private banks in Asia, with “inflows positive, but lower than in previous years”, and a movement among the client base towards greater allocation to advisory and discretionary mandates.
Global private banking is, in fact, being reshaped by the rise of the emerging markets far more than many other segments of the financial services industry, not least because so much of the new wealth being generated in Asia and elsewhere remains in private hands. McKinsey cites “the shift in growth and profit pools towards developing economies” as one of the forces most directly influencing industry development. By its figures, Asia ex-Japan “is expected to be the second largest wealth market globally”, with HNW AUM of $16 trillion by 2016, at around 15% CAGR from 2012. India is more of an opportunity in itself, but one with some very attractive dynamics. “The UHNW segment, where individuals hold assets in excess of $40 million, is the prime opportunity in India and accounts for over 60% of private bank AUM”, observes McKinsey. “Moreover, with an annual growth rate of AUM in excess of 50%, this segment is expanding faster than the overall market”. Given this, it is no surprise that “the profitability of Indian private banks… is close to the level of European peers”.
However, investor behaviour in Asia is by no means the same as in mature Western private banking environments, even in the region’s most developed and longest-established financial centres. The LGT Private Banking Asia Report 2012/2013, examining the investment behaviour of HNW individuals in Hong Kong and Singapore, and in Switzerland, found that “private banking clients in Singapore currently invest around half their assets in cash funds. In Hong Kong this share is around one-third, and around one-quarter in Switzerland”. Gold also enjoys predictable popularity in Asia, at up to 28% of non-cash assets in precious metals or commodities in Singapore and 14% in Hong Kong, versus just 8% in Switzerland. Private bankers from older European centres especially are going to have to adapt quickly to such very different demands.
Generational change, for instance, is hardly an opportunity in a market like China where most of the wealth comes from first-generation entrepreneurs. “The transfer of wealth across generations is a dominant theme in Europe’s mature markets”, observes PwC. “In contrast, wealth management throughout Asia’s emerging markets has a greater emphasis on wealth creation”.
In fact, according to LGT’s poll, Asian expectations are pitched so high that some wealth managers from more mature markets may have trouble adjusting to them. The targeted mean return from assets over the next five years is 15.2% p.a. for Hong Kong and 13.3% p.a. for Singapore in LGT’s survey, versus only 5.5% p.a. in Switzerland.
“Achieving a better return is the most important need in Asia”, concedes LGT. “Achieving a better return on investments thanks to advice from the bank is considered the principal need of private banking clients in both Hong Kong and Singapore”. Wealth management providers unable to meet those kinds of targets – or to educate clients out of apparently inflated expectations – are likely to struggle.
And the supporting cost dynamics of private banking operations in the region are unlikely to be much help. “In Asia, margins continue to be compressed through competition”, warns the Newtone/A.T. Kearney poll. “The private banking industry’s cost-income ratio hovers at about 80%… an increase of almost ten percentage points from pre-GFC”. Cost of opportunity could also accelerate consolidation: with fierce competition and falling revenues in Asia, many houses may simply retreat from one of the most promising growth regions left, yielding the floor to Asian firms that, in some cases, have more indulgent boards or less stern regulators. “Developing a differentiated value proposition and go-to-market model that reflects the diversity of Asia’s markets are the keys to success”, says McKinsey.
And as an adjunct to growth in emerging markets comes the issue of brand management, as a well-established and reputable brand can often be the market entrant’s best ally in a market like Asia. “Premium brand and reputation remain wealth management’s principal differentiator”, confirms PwC. “Brand is becoming a more important part of the proposition and a differentiating factor. There is a greater need to preserve and enhance the reputation of the external brand”. Obviously, brand helps to buttress credibility when dealing with often first-generation clients who may have little experience of private wealth management and who are used to a high-growth, entrepreneurial environment.
This emphasis on brand, however, requires core values and a brand identity to be projected through the brand messages. There, private banks could have problems. “The building block of defining a set of values for the bank has not been the logical first step. This has led to opportunistic behaviour where the banks try to be a ‘jack of all trades but master of none’”, notes the Newtone/A.T. Kearney report. The corollary of this is that “banks have to define and communicate very clearly what their values are”. However, this will also require some banks to make some difficult choices, because “(doing so) will determine the clients they work with, the purpose of their investments and the products and services they offer”.
“The reshaping of the industry is in its early stages and players will need to make key choices about where and how they compete across their business model”, concurs PwC. Obviously, some firms are still reluctant to make that choice.
But some decision-making may be long overdue, not least because of the thorny question of pricing. “Transparency in fee structures is gradually allowing the client to understand what they are paying for and exactly how much they are spending, but this is only the first step in a more fundamental transformation”, cautions the Newtone/A.T. Kearney study. “Regulators across Europe and Asia are now enforcing transparency in fee schedules. This is linked to actual billing, theoretical billing and, more importantly, the added value of each service. The majority of private banks, however, do not yet have the capability to distinguish between these elements”. And market penetration into new regions is only driving up the emphasis on this area. “Newly emerging markets are leading the way on cost-managed growth”, the PwC report observes, while adding, “continued margin pressures in established markets means that cost and efficiency management needs to be taken to the next level… client and regulator demands for transparency are rippling across the entire value chain”.
The industry’s current bugbear of regulation may be unwelcome, but it could also be a warning the industry needs to heed. Regulations, says the Newtone/A.T. Kearney study, “are mistakenly considered to be an external constraint to which the institutions must adapt. In fact, regulatory standards are created to control or correct aberrant behaviour”.
“The private banking and wealth management industry’s trusted adviser status must be restored if it is to prosper sustainably”, claims PwC. “But rebuilding a reputation is easier said than done. Behavioural change is a challenge, requiring time, constant messaging and clear role modelling and tone from organisational leadership”.
Private banking is therefore headed for almost inevitable consolidation. An industry that has built overcapacity and is facing challenges adjusting in a number of dimensions is necessarily going to see some of its members fall by the wayside. If there is an upside to this, it is that the regulatory and economic pressures are purely externals; and there is plenty that the banks themselves can do to fix things.