Private banking is one of the most attractive businesses in the banking industry, with average pre-tax margins of over 35 per cent and a rec...

Private banking is one of the most attractive businesses in the banking industry, with average pre-tax margins of over 35 per cent and a recent growth rate twice that of retail banking, according to McKinsey’s latest annual survey of European private banking.

But far from being saturated, the market still has significant unmet demand, with only about half of the assets held by high net worth individuals managed by private banks, says McKinsey.

In 2005 profits grew by 23 per cent, according to the survey, with asset growth accounting for over two thirds of the increase: 9 per cent is due to improved investment performance and 7 per cent due to net inflows.

McKinsey put the remainder of the profits rise down to an increase in average profit margins: they increased by 2 basis points to 37 basis points as a result of revenue margins growing faster than costs.

The survey, based on data from 68 European private banks, found that there is sometimes a startling difference between individual players’ performance.

Top quartile asset growth averages 32 per cent while bottom quartile growth is 7 per cent.

The benchmarking also reveals important insights into the diverging profile and investing habits of high net worth individuals across Europe.

Unsurprisingly, the report notes that there is no single client profile. Half of all private banking clients are over 60 years old, but another third is in the 40-60 year age group and the rest are even younger.

And while the number of clients with assets over €10 million in any single bank is very small their aggregate assets represent 37 per cent of the total asset base of private banks.

In comparison, the affluent section with under €1 million still represent 24 per cent of the asset base.

Looking at the ultra high net worth clients with assets over €30 million, the survey indicates that they invest differently from the HNW segment, showing a distinct preference towards equity as an asset class, with nearly half their assets invested in equities compared to 30 per cent for HNWs.

Almost 60 per cent of UHNW clients delegate the investment decision to the private bank or pay a fee for an advisory mandate - almost as much as the HNW group, according to the survey.

This year’s survey found that there is no single European investment profile. HNWs invest over 35 per cent of their assets in equities in the UK, Spain, Portugal and Belgium, but less than 27 per cent in Italy and The Netherlands.

Discretionary mandates represent a third or more of the assets in Belgium, Italy, Spain, Portugal and the UK, but less than 20 per cent in The Netherlands and Germany.

From the research, McKinsey has picked out seven factors that it believes will determine private banks’ future growth prospects.

Balancing exposure to onshore or offshore markets is critical in determining the growth prospects of a private bank, say the consultants. Onshore banks have grown by 43 per cent from 2003-05, compared with just 17 per cent growth for offshore banks.

Country focus and timing of entry in a new market are of critical importance: correctly assessing the timing of repatriation of offshore funds or of dematerialization of securities makes a big difference. The report pointing to the growth of the Belgian private banking market of 87 per cent compared with 34 per cent in Europe over the last three years is the latest illustration of this.

The survey also found that universal banks on average lose market share to independent players and new entrants onshore.

Despite their ability to leverage their captive retail and commercial banking channels
to attract new clients, universal banks have lost on average about 5 per cent market share over three years, but still remain the dominant players in onshore Europe.

Less than half of universal banking players effectively leverage their retail and corporate network to source new clients or prospects, according to McKinsey.

And echoing previous research from Boston Consulting Group, the new research points to players focusing on customers with over €10 million in assets growing faster (24 per cent) than the others (15 per cent), not only because of slightly higher growth in these segments but also because developing a truly distinctive ultra-HNW proposition helps them compete more effectively across the board.

Private banks also need to go beyond merely offering a lot of products, say McKinsey. The report notes that most banks offer most asset classes and have expanded into products such as lending, insurance and trust, which represent about 20 per cent of their revenues.

But offering more products in an asset class is often counter-productive due to the complexity it induces for both relationship managers and clients.

McKinsey are also worried that only 40 per cent of private banks describe their average relationship manager as knowing the basic products and services fully. In the years to come, talent will likely become the number one constraint for growth says the consultant.

The report advises that excellent quality of service and advice clearly drives client acquisition and retention. Most successful players appropriately structure products around investment objectives rather than simply advise on asset classes and markets. They also take into account non-financial assets and liabilities.

And lastly, consistent investment performance is critical. Professional investment management should be a cornerstone of any private bank’s proposition. There is though still a very wide gap between the best and worst performance, with often limited transparency.