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Changing The Scope of Private Banking

A staff reporter

29 January 2005

As the summer months take a grip on the financial services sector, there is a chance to reflect on the events of the first half of 2000 and how the industry of private banking is changing its focus. Sebastian Dovey, a Private Client Management advisory board member and a director of strategy think tank Scorpio Partnership, takes stock and identifies some key issues that industry strategists should now consider. Perhaps by now the slew of summer surveys published by management consultants, research houses and private banks are coming to an end and private banking management can spend time reviewing the results. All should be asking – what does this mean to our business? The main survey findings underscore, in our opinion at Scorpio, three key points that have gradually been adopted by the global private banking market since mid-2000. One, the domain of traditional private banking is now firmly in the US$5 million and above bracket. Indeed, private banks that wish to continue to enjoy more than a 50 basis point net yield will now have to rationalise their business lines. Major global private banks including the likes of JP Morgan Chase and Citigroup Private Bank are now formally raising their minimum investment bar closer to this level. Booz Allen & Hamilton survey reports, the growth rate in private investors with this amount of investable capital is still at 12 per cent, which is considerably higher than the growth rates of the total wealth management market as outlined by Merrill Lynch Cap Gemini Ernst & Young. The stronger growth rate underscores the argument that the main business focus should be on the higher tier of wealth. Banks that cannot regularly achieve a yield near to the 50bp mark – and from our data tracking there are several – should be prepared to accept that private banking might not be an ideal market for them. I draw your attention to an analysis piece Scorpio Partnership wrote on this subject last December that is stored in the ‘Contributors’ section of Private Client Management which stated the case that the new asset level makes economic sense. Among the surveys recently which have come out echoing our viewpoint through their own independent research is the US are the one by the Boston consultancy, Cerulli Associates. Since we published that analysis, as a firm we have been advising several of our institutional clients to consider their strategy operating both above and below this asset level. The margins are too low to support a sustainable business proposition that offers full-service private banking. Moreover, the distractions of a volume-driven business such as the mass affluent market are likely to dilute the performance of a private banking operation that is working alongside a premier service and dipping into the same pool of resources, products and services. Two, wealth class segmentation is now beginning to take a grip on the private banking business. Strategically, private banks should not just consider the assets of the clients as the only delineating factor between whether they are eligible or not for access. Indeed, industry players must now also review the sources of wealth in order to best respond to the client demand with appropriate product and service. Essentially, private banks are trying to develop an affinity with various wealth class communities as a better way of increasing market share. A false start was made by many European private banks in 1999 with the launch the family office services. While these have not been the success story many had hoped for, it stimulated banks to construct a more committed segmentation of internal resources to meet the demand of separate wealth sectors. The emergence of specialist teams focusing on entrepreneurs, sports and entertainment, charities, lapidary and the like are all testimony to this shift. One has only to scan through the ‘Wealth Class’ section of Private Client Management to consider the changes taking places in the past six months in this area. These specialist teams need to tailor product and services that can accommodate the demands of specific wealth classes. Banks in the UK such as Schroders, HSBC Republic and Singer & Friedlander are all concentrating on specific wealth classes. While in Europe, UBS Private Banking, Credit Suisse Private Bank, BNP Paribas, Robeco and ABN AMRO are among those moving in the same direction. Three, alternative products – and by this I do not only mean hedge funds – are rapidly becoming the lifeline for many private banks seeking to shore up falling fee income for wealth management. The area of alternative investment has always tended to maintain a level of mystique and elitism for private investors. In recent months, the explosion in demand for hedge funds and particularly funds of hedge funds has shown that many more investors want access and are prepared to pay for them. Indeed, reports in Private Client Management have shown that standard allocation levels for alternative investments are now nearing 20 per cent for most clients. Again, the Merrill Lynch Cap Gemini Ernst & Young survey did much to put a spotlight on this trend. However, as we have pointed out in Scorpio Partnership analysis through 2000-2001, there is a concern particularly among the hedge fund industry that the increased demand, being hyped further by aggressive private banking marketing, is forcing a capacity issue. An assessment undertaken by ourselves that is excerpted in the ‘Contributors’ section provides an overview of the concerns. A separate issue to consider is that alternative investments spans a range of other asset classes that have to date not received much committed attention. Particularly, venture capital and private equity – both of which are popular among the top tier of private clients. Scorpio Partnership is due soon to release a detailed study on this market area and preliminary results indicate that demand among high-net-worth investors is surging as mainstream equity markets are being tamed. Private investors with liquidity are actively seeking new investment opportunities and, particularly in the area of early stage venture capital, they are able to benefit from substantial tax breaks in most western economies as governments strive to support new economy ventures. The issue is whether private bankers are sufficiently competent to assist their clients in making investment decisions in this area. A number in the United Kingdom and the United States are now actively developing specialist teams that can support clients with their VC-based corporate finance objectives. A recent feature in Private Client Management highlighted that credit is an important hook banks are now using to woo new business. The fact remains that while credit may not be a major revenue generator for private banks it can be used as a gateway to offering private clients much need investment advisory support that is unique to the client and still comes at a respectable price. So, in conclusion, it seems to Scorpio Partnership that the summer survey frenzy has done much to crystallise strategic thinking in private banking. The business has moved up a level in terms of asset base, yet the principles of wealth management remain largely the same. Meanwhile, the standard of competition is obviously improving – indeed, if it was not doing so then questions should be asked. Looking ahead, the issue is now to consider new ways of benchmarking success in the private banking sector. Assets are not the only obvious guides to success. Profitability is a more realistic measure. Crucially, most industry players continue to be uncertain of where they stand in the pecking order and it matters to them where they stand. Again, I draw your attention to an analysis piece delivered by Scorpio in September 2000 that first raised the spectre of identifying who was leading whom in the market. We anticipate that in the third quarter there will be a collection of interesting mergers and acquisitions, particularly among the major institutions. In our opinion, this will serve to underline who is playing at the top table and who should just stick to targeting the mass affluent.