The good news? European private banking
continues to grow at a brisk pace. The bad news? The top players
are significantly increasing their market share, which means that
the rest are going to find it tougher in future. The top firms are
growing ten times more quickly than the bottom ones.

While private banking in Europe continues to expand overall, the
top-performing companies are increasingly outpacing their lagging
rivals in a steadily more demanding competitive arena.

These winning top-quartile wealth players grew last year by 31
percent, more than ten times more quickly than bottom-quartile
firms, which clearly indicated “a rising bar for capturing the full
growth potential” for the high net worth in Europe, according to
new analysis by consultancy McKinsey.

One factor may account for the accelerating growth of
discriminating ultra high net worth clients (UHNW), who are now
estimated to account for more than one-quarter of private banks’
assets in Europe and who insist on a blue-riband service.

“Great competition, following several years of attractive results,
increased professionalism within many private banks, high growth in
more demanding segments and more innovative product offerings have
all helped widen the gap between the best and the rest,” says
Frederic Vandenberghe, Mc­Kinsey partner and leader of its European
private banking practice.

The consultancy’s European private banking survey, based this year
on responses by 105 firms across the continent, is regarded to be
among the best research on the state of the industry to come out
annually.

Winners and losers

The distinction between winners and losers is also apparent within
a range of business models, McKinsey noted. Although the big
onshore universal banks are still losing market share on average,
there is a contrasting picture in which one half of universal banks
are gaining market share in their local markets and the other half
are losing market share very rapidly, the survey showed.

The universal banks that gain market share distinguish themselves
from the ones that don’t on multiple fronts, according to the
findings.

These winners typically achieve significantly better investment
performance, they manage to outgrow the market in the
fastest-growing UHNW market – which grows at 36 percent rather than
21 percent for universal banks losing share – and they optimally
leverage their captive channels, such as their retail, commercial
and investment banking networks to attract new clients.

For example, more than three-quarters of entrepreneurs would be
perfectly willing to use the same bank for their private and
professional needs, the survey noted.

Still, the private banking industry in Europe demonstrated another
year of impressive growth in assets and profits, and the industry’s
long-term fundamentals still look very good, Vandenberghe
commented.

The private banking business notched up pre-tax profit margins of
35 percent. While the European ‘private pool’ has more than doubled
since 2002, the market still shows significant potential for growth
and is expected to grow more quickly than GDP.

Far from seeing market saturation, McKinsey sees what it calls
“significant unmet demand”. Private banks currently capture only
half the onshore financial assets held by high net worth
individuals, it estimates.

Overall, McKinsey analysis shows that assets managed by private
banks in Europe grew by 14 percent last year. Investment
performance of 6 percent was three percentage points lower than in
2005, but net new money inflows grew from 7 percent in 2005 to 8
percent in 2006.

While this favourable cycle has helped most private banks to
prosper, the increasing complexity and sophistication of clients
and offerings, and the further professionalism of selected players,
means that “the bar to be among the winners continues to rise”,
says the report.

Vandenberghe declares: “The winning banks will be those that are
able to innovate and tailor client service and products, invest
effectively and consistently in growth and talent, deliver quality
advice in a more complex investment universe and tap into new
growth markets.”

As the wealth industry matures, the drivers of growth are shifting,
the survey asserted. The main growth has come from the more
sophisticated segments and products driven by UHNW investors, who
have more than €30 million ($44 million) in liquid assets in one
bank as well as alternative investment products, such as
commodities, hedge funds, structured products and real
estate.

The survey also identified growth in banks concentrating on the
fastest-growing offshore markets of Asia, Middle East and Eastern
Europe, as they have been able to increase their exposure to the
UHNW client segment.

 

 

Adapt to conditions

Vandenberghe says that the survey results demonstrate that private
banks wanting to be among the winners should be able to adapt to
tough market conditions and consider a number of options. This
includes adapting their service to the needs of each segment, most
vitally for UHNW clients.

The total wealth of the UHNW client segment served by private banks
grew by 27 percent – partly as greater numbers of high net worth
investors enter this bracket – and represented more than
one-quarter of the total wealth invested in private banks.

“These clients are inherently tougher to serve, as they often
require multiple booking centres around the world, a seamless
integration of asset management and investment banking products,
and very senior/specialized relationship managers,” he said.

Banks clearly betting on this segment will outgrow their
peers.

Banks should also deliver added value to clients, the survey
advised. Professional investment management should be a cornerstone
of any private bank’s proposition. Evidence suggests that the
differences in investment performance between various private banks
are “quite considerable”.

The average performance of a bank’s equity model portfolio can
differ significantly by more than 5 percent between players in the
top and bottom quartiles.

With various regulations gradually calling for increased
transparency of pricing and investment performance, the true added
value of a private bank – based on its relationship managers, and
its portfolio managers – may require further upgrading of
professionalism by some players.

Players should invest consistently in growth, although “growth
comes at a price”, the McKinsey analyst said. The survey results
showed that players that grew their cost base most strongly (by 27
percent) also expanded their base of relationship managers (18
percent) and their assets under management increased above the
average (24 versus 14 percent).

Going with the flow

Worst off were those banks just “going with the flow”, as McKinsey
termed it, and keeping their costs flat. They, on average, lost 9
percent of their relationship managers and grew their assets under
management by only 4 percent, less than the average market
performance.

The consistency of investment in growth will be even more critical
during the next downturn. The McKinsey expert argued: “Private
banks that just try to rise with the tide, not having a clear
growth strategy, are doomed. Not investing is largely equivalent to
slowly running off the franchise. Exiting at current valuation
multiples is likely to be more attractive for them.”

Players should also develop a differentiated talent proposition.
With payouts to relationship managers typically ranging from 7
percent to 15 percent of client revenue and cost-income ratios of
some 65 percent, there is ample space for relationship manager
poaching via increasing salaries, the study observed. Not
surprisingly, hiring relationship managers at higher payouts leads
to significantly higher growth. But, payout is not everything:
banks will need to evolve the way in which they develop and
evaluate talent, McKinsey cautions. “Our belief is that the ‘end
game’ on talent is likely to be closer to professional service
firms or investment banks than to traditional retail or brokerage
environments, Vandenberghe said.

McKinsey thinks players should also “truly broaden” the investment
product range.

Four product categories expanded by more than 30 percent in the
average portfolio of high net worth individuals in 2006:
commodities, hedge funds, structured products and real estate.
These generate more than 15 percent of revenue.

Private banks need to provide not just access to these products
but, more importantly, ensure they have adequate advice and
selection capability.

 As for traditional products, they also need to consider the
“make versus buy” decision, the survey suggests.

Among private banking business models, McKinsey found that the
biggest beneficiaries of growth have been investment banks, due to
their greater exposure to the UHNW segment and focus on alternative
products. But their profitability continues to suffer, as the “high
front-line costs” eat into their margins.

 

Cultivating the ultra high net worth clients

The McKinsey research illustrates that an individual bank’s ability
to capture its share of the industry’s profitable growth is
fundamentally affected by key strategic choices along six
dimensions. These are segment focus, business model, share of
offshore money, the country focus, the product offering and the
consistency and realism of (international) growth strategies.

For example, the UHNW client segment, which accounts for less than
1 percent of all private banking clients, represented 26 percent of
private banks’ assets in 2006, up from 23 percent in 2005.

The asset base of UHNW investors grew by over 27 percent in the
same period, more than twice the asset growth of the high net worth
or affluent segments.

Growth was fuelled by comparatively stronger wealth creation in the
UHNW segment. More high net worth clients crossed the €30 million
threshold and more aggressive asset allocation grew their
portfolios. For example, 42 percent of UHNW assets are invested in
equities, versus 34 percent for an average private banking
client.

The UHNW segment yields average revenue margins of 37 basis point,
which is far lower than the market average of 98 basis points,
McKinsey noted.

“Nevertheless, private bankers would be well advised to develop a
solid ultra high net worth proposition,” the consultancy
advised.

Trend setters

Client needs in this segment can be a precursor to how clients in
the lower wealth bands might evolve. Ultra high net worth clients
are often six to 18 months ahead of the next innovation in private
banking.

Players with a strong UHNW business will therefore be in a better
position to build scale and will be ahead of the competition in
introducing new products and services to their wider client base,
McKinsey thinks.

At the same time, its research shows just how strong has been the
growth in alternative asset classes. Four product groups grew at
least 30 percent in the average portfolio of high net worth in 2006
– commodities, hedge funds, structured products and real estate. By
comparison, the standard product portfolio of equities, fixed
income and cash, which still represents almost 85 percent of
assets, grew at a much lower rate. This ranged from 4 percent for
fixed income up to 15 percent in equities.

“Although structured products, hedge funds and real estate still
comprise less than 10 percent of overall assets, they generate over
15 percent of revenues,” McKinsey notes.