Private banks lowering the bar to pick up profits
Private banks have realised they must turn to the mass wealth market to make money but business models need even more of an overhaul
Private banking groups are fast moving down the food-chain in their quest for a more profitable business model. JP Morgan, once the exclusive champion of the ultra-wealthy, is spreading its tentacles into a mid-market segment in London and is soon likely to roll out this service in other parts of Europe.
Boosting the bank’s brand among those with €5m to invest would previously have been an unthinkable strategy, ridiculed at the institution’s private banking arm. But in newly appointed offices in Knightsbridge, overlooking the UK capital’s Hyde Park, CEO Pablo Garnica and his team of London lieutenants are devoting serious resources to the high net worth (HNW) segment.
While wealth managers across the board are doing their best to tap the largest pools of entrepreneurial wealth in developing markets such as Asia, the Middle East, Africa and Russia, HNW and mass affluent targets are attracting increasing attention.
These markets typically pay bankers 1 per cent per year in rewards, compared to less than half of this for the richest segment, says Seb Dovey of wealth management think-tank Scorpio Partnership. Mass affluent markets pay up to 1.5 per cent.
The story is the same in China, seen as the biggest prize among global banks. According to the China Private Wealth Report, compiled by consultancy Bain & Co. in conjunction with China Merchants Bank, there were 700,000 HNWs in China at the end of 2012. Numbers of these potential private banking clients, with more than $1.6m (€1.2m) of investable assets, have more than doubled since the end of 2008.
But many banks, especially the foreign players such as Singapore’s DBS are targeting the “young climbers” segment, those with €50,000 to invest, with even greater vigour. Currently this pool is made up of 128m people in China and is growing fast.
A lot of banks get carried away by the spirit of adventure and global expansion
There is no option for banks but to attack the lower segments, believes Mr Dovey, with markets close to home often the most lucrative. “A lot of banks get carried away by the spirit of adventure and global expansion,” he believes. Banks are increasingly realising there is a margin to be extracted both locally and mid-market.
But the questions many banks are asking themselves are not really deep enough, believes Amin Rajan, CEO of the Create research consultancy. Because markets are not growing, there is a significant fee compression in every segment, with HNW investors unwilling to put any money into high octane fee-bearing products and retail investors opting for cheap index funds. Mr Rajan asks: “Who will pay the fees they were paying in 2008 in today’s climate, where risk and return are so uncertain?”
Private banks can continue to grow, he says, but they must update their business models. Firstly, this means ditching outdated “mean-variance” optimisation methodology in asset allocation. Secondly, client expectations need to be better managed and thirdly, operating expenses need to be reduced.
An excellent case study of how European banks are shaping up to these challenges is KBC in Belgium. The institution is faced with massive competition in a tight domestic market from the likes of BNP Paribas, which recently bought up the Fortis chain, ING and a few smaller but well-recognised boutique operations.
Despite this and less than generous GDP growth forecasts, KBC expects its private banking franchise to outpace the economy due to three factors.
Firstly, there is a definite trend in Europe for private banking clients to move assets back onshore to home markets, as regulatory constraints begin to bite. Secondly, SME owners have been quietly increasing their wealth and many are set to retire and sell up during the next five years.
Lastly, claims the bank, as financial risks decline, wealthy individuals will begin to concentrate assets with a handful of favoured providers, leading to opportunities for stronger players.
Having surveyed the profitability of various parts of the market-place, although KBC wants to be a strong player in both mass affluent and ‘ultra’ segments, it is concentrating marketing efforts on the €1m to €10m segment. While the bank appears domestically focused, there are elements in various outposts which contribute significantly, particularly in Central and Eastern Europe, where KBC manages €5bn across the Czech Republic, Slovakia and Hungary.
Defining the proposition is a trickier one for banks in Spain, a country hit badly by the Euro crisis. Because there is little generation of new wealth, banks such as La Caixa, which manages €42bn for private clients, are focused on redefining exactly what they provide for these customers.
The challenge to recover profitability, as fees move down and costs rise, involves moving clients to riskier assets, associated with higher fees. This means more work in what the bank calls the “relationship space”, converting existing assets to new strategies.
The most profitable segment for La Caixa, and the one where it will be concentrating most efforts, is that of customers with €0.5m to €2m to invest. But 15 to 20 per cent of the “domestic market” is still outside Spain, and all of the country’s banks are working hard to capture this money.
Management at the private banking arm of La Caixa believes it is too early to start diversifying to markets outside Spain, with Latin America the natural first port of call. The bank sees this as a “strategic business”, following purchases of stakes in Inbursa in Mexico, Erste in Central Europe and the Bank of East Asia in Singapore in 2008.
Rather than becoming too concerned with the private banking possibilities in these markets, as yet, La Caixa’s management is investing heavily in technology at home, to bring relationship managers closer to clients and to increase the frequency of contact.
There is some synergy here with private client needs, with many complaining contact is always over the telephone, in terms of sales calls, when they need more apps and access to intranets and user groups.
Yet this can also prove a dangerous strategy, believes Create’s Mr Rajan. Because client accounts become just names and numbers in a mechanised customer-service system, when they are mis-sold products, it becomes a victimless crime. There is less and less face to face contact, he says. “How do you know the mindset of your client and their risk tolerances, aims and asset preferences, when you don’t really know them at all?”
