Private banking: The cost of transparency
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|
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."
One consultant says: "Some markets are just too difficult to succeed in without scale and some sort of differentiator or historical hook; now there is the perfect excuse to pull out of markets that before you just had to be in."
There has been a renewed attempt to increase profitability in domestic markets instead. Some US banks, for example, hastened a retreat from international businesses – with Bank of America Merrill Lynch now almost entirely US in its focus. Morgan Stanley also retreated, selling its European business to Credit Suisse – Europe has always been a difficult market for US players and vice versa. Citi has remained global like JPMorgan, but has also been expanding in its home nation. Mark Mason, CEO of Citi Private Bank, says that its west coast operations have been growing rapidly following investment. Sallie Krawcheck, former CEO of Bank of America Merrill Lynch’s wealth management business, says that in domestic markets the large players actually gained market share in the crisis. "While socially ‘too big to fail’ is frowned upon, clients would rather bank with one of the TBTF banks. So interestingly the US banks gained on their home turf."
Although the cost and complexity of regulation appears to be an obstacle to revenue growth, it is possible that these years will be looked back on as a positive turning point not just for clients, but also for the larger banks.
Phil di Iorio, CEO at JPMorgan Private Bank, says increased know-your-client standards are helpful to everyone: "Traditionally, clients wouldn’t discuss their other financial providers, how much they had invested away, with whom, and in what asset classes. Now new regulations require a more comprehensive knowledge of your clients’ investments." That gives the banker a better chance to know the client more intimately and to offer better advice. It also gives them a chance to offer equivalent products to their peers and poach clients.
But for clients it also means: why bank with five banks when there is no discretion now in doing so? Why not just pick a couple? That means market share is up for grabs, and the larger banks have a chance at winning it with a one-stop-shop offering.
The third prong in the model overhaul for private banks is in revamping technology. The back office is where most of the challenges lie. The systems for monitoring clients, data mining, compliance measures and reporting are so complex and old in some cases that complete overhauls are crucial. Yet the costs are extensive. One US wealth manager within a larger organization has legacy systems from the 1970s that it has been trying to upgrade for years. A total overhaul would be costly, risky and complex.
As one former head of a European private bank says: "The real costs lie in the legacy systems at some banks. Not because they are ‘bad’, but rather that the data is incomplete or the systems don’t talk to each other. Those have to be upgraded and the numbers are just terrifying. If you don’t have scale, you just cannot afford to do it."
Even with scale, if private banking is not the core business within the franchise, getting approval for billion-dollar upgrades from the board in the current environment is challenging. Another banker complains that technology staff who implemented the systems or work with them currently are often reluctant to support suggested changes. "It’s a nightmare getting IT to back you up on overhauling a system as they won’t admit the current situation is terrible," he says.
Bizzozero at Deutsche Bank says improving technology has to be viewed as less of a cost game and more of an investment. "It will drive efficiencies and reduce complexities. It should mean that we will be able to better deliver high-quality service and increase performance." He says many of the banks will be thinking about outsourcing their back-office operations to a technology platform. Deutsche has already done so for its Swiss private bank.
|Sallie Krawcheck, former CEO of Bank of America Merrill Lynch’s wealth management business|
Krawcheck agrees that while it’s hard to measure the cost benefits of investments in technology, they absolutely exist. "Anything that enables a banker to spend more time on a relationship is worth it," she says. "Advisers are advisers – they aren’t box checkers or compliance guys. If you want to increase productivity and revenues you have to free them up to do what they do best. One reason Merrill Lynch’s advisers were so productive was because they had the technology."
On the client-facing end, technology investments are seen as easier to facilitate. Most are new projects such as mobile client and relationship manager systems and are less of a headache to price and amend than back-office overhauls.
Every private bank is now piloting or launching some form of mobile technology. Citi Private Bank is launching an entirely new client engagement platform in February that has been 18 months in the making. Dena Brumpton, who is overseeing the project out of London, says the net cost was actually zero as it was investment redeployed from other Citi projects. Citi’s platform enables clients and bankers to access the same data and communicate by video. The platform has a digital vault for private files and documents, trading and research as well as investment reports, and will ultimately have crowd-sourced investment themes. Other banks have more basic mobile platforms that act more simply as a way for clients to look at their accounts and see their risk weightings. Banks are also working with third parties, such as Dragon Wealth in Singapore, which have created technology that offers clients peer portfolio comparisons and more targeted investment ideas based on their activity and demographic.
The problem is, although there is clearly a first-mover advantage, ultimately the technology will be replicated among all the private banks. A new paradigm may be emerging for the industry and models are being overhauled, but the danger is that the players that dominate will be indistinguishable other than by where they are headquartered.
If banks want to differentiate themselves then they have to be smarter about their proposition. The former head of a wealth manager hints that in a few years there will be another wave of consolidation among the bigger players. "There was a time when wealth management was seen as the raison d’être for most big financial institutions, but that is no longer the case because of cost and revenues. If you don’t have a reason to be in it, or a differentiating proposition, you are going to question why you are there."
It’s a good point, but profitability is likely to increase and keep many financial institutions in the game, particularly as rates start to rise. "The most valuable revenue is that of net interest income, as not a single client sees rates increase and asks for more bankers," says Krawcheck. "At Merrill Lynch, when commissions declined, advisers shifted their business into lending and deposits. It’s a cyclical business; it is not written in stone that profitability has to decline." She adds, though, that no one needs to reinvent the wheel in private banking.
Whatever CEOs say, relationship managers are the main reason clients choose a bank and stay with it and that has always been the case for private banking. Creating models, processes and systems that efficiently allocate clients’ assets and improve performance is all well and good, as is developing technologies to improve client interaction and ease of banking. But as Vincent Lecomte, co-CEO at BNP Paribas, says: "The relationship managers remain the entry point to the bank and always will. And it is those who really make the difference in the business, so that is where the focus needs to be."