Private banking: The cost of transparency

Helen Avery
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Offshore secret bank accounts are out and onshore wealth management is in as the world’s private banks are forced to adapt to higher costs and lower revenues. But will it lead to a homogeneous industry?

The paradigm shift in wealth management is as big as the one that is taking place in investment banking," says Juerg Zeltner, chief executive of UBS Wealth Management. Although model changes and strategy overhauls have been topics of discussion since the financial crisis, the industry is still struggling to reinvent itself, he says. "Clients have had such a painful deleveraging, and we won’t see levels again like those pre-crisis, so the top line is under threat. And the cost to serve clients is growing. Everyone knows they have to change the model, but not everyone knows how to do it or can afford to do it."

Marco Bizzozero, CEO of Deutsche Bank Switzerland and head of wealth management EMEA, says that now is crunch time. "The discretionary cost-cutting has been done and now banks are in the process of looking at the fundamentals of the business and optimizing the entire value chain from front to back office. Where is the focus? Where do we need to invest in and retreat from?"

Indeed costs have been slashed. Credit Suisse has reduced costs for the whole group by SFr3.5 billion ($3.85 billion). UBS shrank its balance sheet from SFr2.6 trillion in 2007 to SFr1 trillion.

Although the world’s wealthy are continuing to grow in number, cost increases have made private banking a less attractive proposition. Regulation, which formerly remained on the horizon or restricted to certain countries, is now being enforced in every region. Cost of compliance is given by private bank executives as the biggest pressure on profits. Cost-income ratios at the largest global private banks have gone up since the crisis. UBS Wealth Management’s cost-income ratio for the end of the third quarter last year was 68.7 year-to-date from 58.4 at the end of 2008. HSBC’s cost-income ratio for the global private bank rocketed to 93.3 at the end of the third quarter last year from 60.5 at the end of 2009.

It is not just regulation that is bumping up costs. Although the basic expenses of real estate and remuneration have remained fairly static in western Europe and the Americas, in emerging markets it is a different story. The Asian arms of global private banks have cost-income ratios up in the 80s because of expensive real estate and a struggle for talent that pushes hiring costs upwards. And finally, technology and infrastructure overhauls have gone from ‘would likes’ to ‘must haves’ as one former chief executive of a European private bank describes them.

The pressure on cost is accompanied by pressure on revenues. High-net-worth clients are still holding large amounts of cash instead of investing in high-margin products, while low interest rates continue to keep profits down and lending revenues inconsequential.

One of the most important changes at the leading wealth managers has been to focus much more on making returns to clients through traditional asset management techniques.

With regulation increasing the cost and complexity of being a global player, private banks have had to rethink their geographical positioning. It’s not new. Private banks are notorious for moving in and out of regions in line with market cycles, but this wave of movement seems more forced than in others. The offshore model has taken a big hit. If transparency is now the new norm, why bank offshore? "The days of using the offshore model for the sole purpose of bank client confidentiality are gone," says Zeltner.

Instead offshore will be a model clients use to diversify assets globally, as well as for currency and risk management. But as Hans-Ulrich Meister, head of private banking and wealth management at Credit Suisse, points out: "If you want to play in that space you’re going to need economies of scale. The landscape will look different in a year or two."

Luis Moreno, head of the private banking, asset management and insurance division at Santander
Luis Moreno, head of the private banking, asset management and insurance division at Santander
And where you are onshore, can you really afford to be so now that regulation is country-specific? "Strict supervision is as important and effective, if not more, than strict regulation," says Luis Moreno, head of the private banking, asset management and insurance division at Santander. "There are rules that have made it too costly for some banks to have operations in countries for the sake of it,"he says. "The regulations are different in different countries and are moving at different speeds. You have to have specialists in every country who understand the regulation. Then you have to train the bankers to understand it. And then upgrade the IT systems to work with it. You have to focus on the countries that you can be profitable in, where you can leverage the whole group."

Barclays Wealth also exited some markets. CEO Peter Horrell says: "We have been very clear that sourcing business in every market is not a sustainable model; both the costs and the potential risks are too high. We opted to focus on competing where we feel we have scale and where we feel we can win. We announced in September last year that we would be prospecting in only 70 markets from our offices in 20 countries across the world. We believe that this still enables us to access more than 80% of the world’s wealth, while running a less complex business."