Private Banks: Adapting for future growth

Recent half-year results announcements by Swiss private banks have shown a number of similarities: cash-related business has grown significantly, transaction and fee income is under pressure, and net new money (NNM) is seeing fairly weak growth. This is a clear reflection of the fundamental trends in our industry.

Firstly, the figures show that clients are highly risk-averse, even accepting negative interest rates on short-term investments. Clients are also seeking refuge in stable but low-yielding bond investments, aiming to preserve their capital and obtain a limited but guaranteed income until maturity. The situation has enabled private banks to sharply increase their interest-related revenues, taking advantage of opportunities to invest excess portfolio cash, as well as growing loan books as a result of very low borrowing rates. It is an unusual situation for these banks, whose main remit is to provide advice and manage portfolios in return for a fee, and which are generally very cautious in their asset/liability management.

We are also seeing a decline in trading activity, which is affecting brokerage revenue. This trend is not being caused solely by client risk aversion, but also by increasing regulatory constraints. Current regulations in Switzerland and across all financial markets are aimed at making bank fees more transparent, providing necessary controls over products sold in each country, defining cross-border rules and ensuring that products are always aligned with clients' risk profiles. These regulations are now applied by all banks, and the new environment they have created is making banks less responsive and restricting the scope of their activity, inevitably pushing down volumes and therefore reducing brokerage revenue. On top of that, there is a big shift among the most active "self-directed" clients towards more suitable and less costly solutions, such as online brokers.

Banks' results for the first half of 2016 highlight ongoing low levels of net new money, a situation that KPMG describes as "No New Money" in its report entitled Clarity on Performance of Swiss Private Banks. Even though everyone agrees about the long-term growth potential of the client segments targeted by private banks, it is a zero-sum game: in a low-growth world, genuine wealth creation is limited, and any increase in assets under management is being driven by the performance of listed assets. Variations in the amount of NNM being attracted by the various banks are mainly to do with differences in recruitment and acquisition strategies. In simple terms, business lost by one bank is gained by another, but meanwhile margins are being eroded across the board. At the same time, banks are now missing out on a large proportion of wealth creation as clients shift towards direct investments. Overall, adding in the business impact of tax compliance programmes, private banks' performance in terms of NNM was disappointing in the first half of 2016 and has been for several years now.

In this gloomy environment, we can acknowledge two facts: firstly, in order to maintain their growth strategies, private banks are taking the risk that their profitability and balance-sheet strength will deteriorate over the long term. Secondly, they are having to deal with losing market share to direct investments, which are attracting a rising proportion of global wealth. Of course, real estate is an asset class that has always been over-represented in global client wealth. However, at a time when returns on risk-free assets are so low, clients are increasingly focusing on direct investments, including real estate, infrastructure, new technologies, aircraft and gold.

It is still the case that the main rivals to private banks are other private banks. More than ever, however, they are also seeing competition from direct investments that bypass private banks, generating little revenue for them, except possibly the interest on mortgages used to buy real estate. Direct investments are attracting an increasing proportion of investment flows, but are still marginal in terms of private banks' overall revenues.

Private banks' growth issues are not solely related to reduced wealth creation and stiffer competition: they are also being caused by insufficient returns from traditional assets and the increasing appeal of direct investments. The trend is confirmed by the amount of funds that can now be raised for technology, venture capital and infrastructure projects. Overall, a significant portion of new savings flows are bypassing the established activities of private banks and are therefore not making any contribution to their growth.

As a result, banks need to make changes in two areas. Firstly, they need to adjust their costs in line with their growth potential and ability to generate revenue. Secondly, they need to reinvent their offering, so that they can continue to capture and manage the bulk of their clients' financial assets and increase NNM, without necessarily engaging in aggressive and costly recruitment policies.