Private banks turning Eastern promise into reality

While the actions of the European and North American authorities, aimed at recouping lost tax revenues from offshore hubs, have eroded the traditional international wealth management business model and lower economic growth in many developed markets is limiting wealth creation, Asia has turned into the battlefield for growth for almost every single private bank in the world.

Asia Pacific is now the second largest region in terms of high net worth wealth after North America and its growth story is fuelled by high savings rates, increased domestic consumption and beneficial demographics.

However, while Asia is estimated to hold 30 per cent of global wealth, only 10 to 15 per cent of the region’s wealth is currently managed by private banks, versus 70 per cent in North America and 30 per cent in Europe. This under-penetration is a unique growth opportunity, says Kathryn Shih, CEO of UBS Wealth Management Asia Pacific. “The wealth pool in Apac is huge but not developed. Wealth in the US and Europe is older, while in Asia it is first or second generation wealth still in the hands of entrepreneurs.”

The demand for wealth management services is increasing over time, as wealth is transferred to the next generation, and corporate liquidity events lead rich entrepreneurs to look for financial planning advice. Challenging markets and a low yield environment are also forcing more people to turn to wealth managers.

But the challenges to building sustainable growth are enormous and newcomers to the region should be particulartly aware of them.

There is a serious talent shortage in the market and the merry-go-round of relationship managers in the industry has caused a massive escalation of salaries. In Hong Kong and Singapore, where today there are an estimated 4,600 private bankers in total, there will be a shortage of 1,600 private bankers in the next five years, due to the increasing number of wealthy people, says Ms Shih.

Declining revenue margins and high cost income ratios are also a major challenge.

Cost-to-income ratios in Asia, for example, are higher than in Europe. Revenues remain challenged due to lower asset levels and lower returns on managed assets. Clients have become more risk-averse, many have de-leveraged their portfolios and have been shifting towards simpler products that yield lower margins for banks, from equities into fixed income.

At the same time, new regulations are negatively affecting revenues while driving up the cost of business. Basel III as a regulatory example will further reduce the ability of banks to use their balance sheets to generate profits.

Many Asian private banks have high growth rates, but low profitability. In the past five years private banks’ profit margins have declined from 35 to 11 basis points in Asia, versus 24 basis points in Europe, according to the McKinsey Private Banking Survey 2012. “Cost management is very important while we are growing and it is vital to start getting performance management in place,” states Ms Shih.

“Capital constraints and tighter profit margins will trigger further industry consolidation and force many competitors to review their ambitions.”

Moreover, of the total $10,700bn (€8,255bn)of HNW assets in Asia, the vast majority, 90 per cent, is onshore wealth. And 40 per cent of the offshore wealth is booked in Hong Kong and Singapore today, according to the BCG Global Wealth report.

“A lot of us are fighting over a small, very expensive and mixed quality talent pool, in Singapore and Hong Kong, when 90 per cent of the wealth is not there,” she says. Wealth is in Japan ($4,231bn), China domestic ($2,706bn), Australia ($542bn), India ($477bn) and so forth, according to the RBC/Capgemini Asia Pacific Wealth Report 2012.

But there are several challenges that prevent private banks from establishing onshore operations, including licencing, high cost of setting up IT infrastructure and a small or non existent talent pool. “Many regulations are aimed at retail banks and brokers, so you have to do a lot of lobbying for regulators to allow you to offer a holistic wealth management,” explains Ms Shih.

Moreover, in these new markets, investors often have high return expectations, as they have made a lot of money in their businesses.

But with all the double tax treaties signed in Hong Kong and Singapore, and the focus on them operating as wealth management centres rather than tax havens, it is very important to start looking at other strategies in addition to just growing these two locations, believes Ms Shih.

Institutions should focus on which markets they want to cover. “As regulations develop and as tax compliance becomes more and more important, domestic businesses start to become more attractive.”

UBS Wealth Management Asia manages $190bn with presence in 13 domestic locations and carefully selects which markets to head to next. The bank has been watching domestic growth markets such as Malaysia from the sidelines, a country which is dominated by local and Singaporean banks.

“Malaysia is not big enough for us to start a wealth management domestic business, with $5bn you would barely break even, to really make money you need $10-15bn,” says Ms Shih.

Enhancing operational efficiencies is a key strategy as economies of scale give banks the upper hand when it comes to managing costs, says Shayne Nelson, global head, High Value Client Coverage & CEO of Private Banking at Standard Chartered.

It is difficult to maintain small operations onshore for many Asian markets, as the product set on the ground is quite limited due to regulation and level of sophistication of the wider client base, he says.

A hub strategy, flying in and out from Hong Kong and Singapore, has been successful for the bank, which also leverages on referrals for its offshore private banking from the consumer and priority banking in countries such as China.

“These days, with increased regulation and infrastructure systems required, to have smaller operations sitting in countries is fraught with regulatory, system, operational and people risk,” says Mr Nelson. “We want to build scale, which allows us to spread the cost of middle and back office and better control over a wider number of relationship managers and revenue pools. Scale is important from a cost perspective but also from a client service perspective.”

A strategy adopted by Standard Chartered has been to migrate private bankers from the bank’s consumer banking and training them. “When priority bankers move to private banking, the growth in their clients’ portfolios has been very good, as clients that had originally spread money around other banks, start concentrating into the private bank,” says Mr Nelson.

Moreover, today banks are more reluctant to pay high salaries to private bankers coming from competitors, he says.

“In the old days, a private banker with a portfolio of $500m would be able to move all of it. Today, if they move 20 or 30 per cent, that would be a reasonable outcome,” explains Mr Nelson. “We have more reticence to pay those big dollars on the promise of AUM shifting, when actually from bitter experience we know it does not happen that often that the private banker brings anywhere near the portfolio he had previously.”

Leverage ratio

Talent remains a key issue and it is crucial to focus on understanding the cost of servicing clients as well as the drivers of relationship manager productivity. “One of the things we look at very closely is the ‘leverage ratio’, which is how much revenue the relationship manager has to his own cost, including potential bonus, in other words how productive he is.”

In the first year, a relationship manager should bring the bank back one time their cost, which means the bank is still losing money, as it has to cover for middle and back office, assistance and so on. In the second year, the relationship manager is expected to cover his cost three times, and then the bank is probably breaking even. It is only in the third year that relationship managers are expected to bring five to six times their cost, and that is when the bank starts making some money.

“Retention of talent is critical,” says Mr Nelson. “You don’t want to be in that cycle where they are changing every two years, because then you are just in a doom loop.”

The other important factor to monitor is the number and size of clients’ assets with each private banker. “One of the things we see in the industry is that often relationship managers have ‘big tails’, ie a lot of clients that bank in that private bank but don’t qualify for private banking. We are pretty tough on that,” he says, explaining that they monitor how quickly new clients move funds when they open an account.

If they do not top up to $2m, which is the threshold to qualify for private banking, they are migrated to a relationship manager in priority banking, which looks after the $100,000 to $2m client segment. This approach increases relationship manager capacity, allowing them to serve and focus on more profitable clients.

One size does not fit all and it is important private bankers know the country’s culture, rules and regulations and can speak the local language, although in some cases financial terms are still being coined.

Mandarin spoken by a Shanghainese is quite different from that spoken by a Northern Chinese or Hong Kong Chinese or Singaporean Chinese. “I have had to sit through a tape of a [mainland] Chinese client giving an option trade order to a Singaporean Chinese trader, whose mandarin was perfectly fluent. They were both saying exactly the same thing in a totally different way,” said Su Shan Tan, group head of Wealth Management at DBS Bank.

“I think the language evolution is still happening. People say China needs a CDO market. I say ‘Let’s get the dictionary right first’.”

Asian clients require both onshore and offshore solutions, but while the onshore solution in the bigger emerging markets countries is about wealth creation, the offshore solution could be more focused on wealth preservation, believes Ms Tan. “Asia is a hotchpotch of jurisdictions, languages, cultures and differences in sectors and wealth creation. The ability to offer both onshore and offshore solutions can create a long-term sticky solution to these new Asian wealth creators.”

Private banks’ lack of proper management over the recent years largely explains their high cost to income ratio, believes Hugues Delcourt, CEO of ABN Amro Private Banking Asia & Middle East. Today it is 85 to 95 per cent, while private banks should aim at 75 per cent.

“When there was growth, people would not pay too much attention on how they structured and managed their operations, because the industry was very much geared towards pushing products, in particular those with very high level of upfront fees to their clients.”

But with margins shrinking, the industry has to learn how to live with lower returns on assets, he says, and therefore cost control becomes increasingly important. “In private banking, people are not good at owning their costs, as the management information available to the department heads is either not sufficient or not analysed sufficiently by the head of the department to be able to challenge this cost,” says Mr Delcourt.

Increasing cost ownership is one of the areas Mr Delcourt focused on since he rejoined the bank in Asia last October in his current role from UBS Luxembourg, after working in Asia for several years in the past. This strategy has substantially contained costs at the bank. “It is like at home with your personal expenses, if you don’t know what you spend or you don’t look at your credit card bills, you have tendency to spend more. This discipline is important to enhance accountability.”

The industry also needs to improve its business processes from account opening to on-boarding clients to order execution. “We need to review, simplify our processes and automate those that can be automated to improve efficiency,” says Mr Delcourt.

Private banks can also act on the revenue side. In Asia in particular, where a transaction oriented model dominated over the past few years, the sales process starts with the budget and how much money needs to be made that month, then looks at the products that need to be sold to generate this money and then finally looks at the clients to target in order to achieve those financial targets through those products.

“This is the wrong sales process. The sales process has to start with listening to the clients and finding solutions that meet those needs and having this leap of faith that by doing this, you will generate revenues for the bank and your budget for the year.”

What is also important is to enhance the discipline in terms of revenue generation, says Mr Delcourt. “The focus should be on price realisation of your business, really looking at how you price your products, how you wave some of the fees and commissions that are associated to your products.”

If banks charged their clients according to the price grid, their revenues would be 50 per cent higher, he says. “This is quite logical, if you are a private banking client with $100m, you do not expect necessarily to pay the same as when you have $1-2m. But sometimes a few of these waivers and exceptions are not reasonable.”

Consolidation ahead

The challenging market environment is likely to prompt further consolidation in the private banking industry in Asia. A number of smaller banks which do not have scale or those that do not have recognisable brand will struggle, but as the sale of Merrill Lynch’s international arm by Julius Baer demonstrates, large businesses too may be affected.

“We can expect some exits from the region in the period ahead,” predicts Ray Soudah, founder of MilleniumAssociates. “In the Merrill Lynch case it was because of capital issues back home and because it was a loss making business. All those institutions that are not adequately profitable and have capital or strategic issues in their home country, European or American banks, will be at risk.”

Another key question is whether large Chinese banks that have such a huge Chinese domestic markets at their doorstep will also prove a potential threat to competitors in the rest of Asia or the world.

“The most sensible thing to do for the Chinese banks would be to rapidly develop an onshore private banking business as a first step and then selectively go where they have a significant subsidiary.” Bank of China had to exit Switzerland as it was not able to gain sufficient business, although this applies to several dozen banks in Switzerland, believes Mr Soudah.

Strategic partnerships like the one Julius Baer Group has established with Bank of China to mutually cross-refer clients may be a good tactic in the short term, he states, but in the long term Chinese banks will have the confidence to attempt acquisitions.

“In the short term, I think these alliances are more symbolic than material. I have not seen many alliances that actually work. Even within large global banks, it is very difficult for different parts of the organisation to cooperate. In an alliance with somebody who is not even a shareholder, it is virtually impossible and a waste of time. If you are going to be in the private banking business, you should be in it on your own,” says Mr Soudah.

Chinese, Indian or big emerging markets banks do not have large private banking operations yet, because the onshore interest rates are so high that their focus is gathering deposits and wealth management is really an after thought for them, says DBS’ Ms Tan. However, they can no longer rest on their laurels and not worry about their fee income as they face increasing competition from non-bank financials, such as for example private equity funds.

“The threat to all of us here could well be the surprise in the next decade, and could be the rise of non-bank financials in emerging Asia,” predicts Ms Tan.

Kathryn Shih, Su Shan Tan and Ray Soudah were among the speakers at PWM’s second annual Asian Private Banking Summit in Singapore

Wealth snapshot

Facts from the RBC Wealth Management and Capgemini World Wealth Report 2012:

• Asia Pacific surpassed North America as the single largest home to HNWs for the first time last year, with 3.37m individuals holding at least $1m in investable assets, compared to 3.35m in North America
• India and Hong Kong registered significant declines in 2011 after leading Asia Pacific growth for the last two years, but the region was compensated by robust growth in the key markets of China, Japan, Thailand Malaysia, and Indonesia
• Losses in Hong Kong and India meant wealth contracted in Asia Pacific overall by 1.1 per cent to $10,700bn after increasing 12.1 per cent in 2010. North American HNWs still accounted for the largest regional share of HNW investable wealth, with $11,400bn

Tracking the Forbes list, 24 per cent of the world's billionaires in 2012 are from Asia (ex Japan) compared to 7 per cent 20 years ago