While long-term prospects for the private banking industry are distinctly positive, private banks need to adapt their business models to the new realities, global management consulting firm Booz & Company said in its latest survey on private banking after the perfect storm. Private banks have spent the last 18 months dealing with one of the most difficult periods in modern financial history. A “perfect storm” of asset-price declines and the near or actual collapse of some of the best-known wealth management firms has altered the behavior of clients, prompting them to move into less risky financial instruments that are much less profitable for the banks. All of this has pushed revenue levels down by 25 to 30 percent. As an added challenge, governments are cracking down on their wealthy citizens' untaxed offshore accounts, forcing many private banks to find new value propositions. Not everything has been negative, however. “Private banks have continued to deliver profits and many banks are starting to move strongly into emerging markets, especially in places like Asia and India where the populations of high-net-worth individuals are expanding rapidly,” said Peter Vayanos, a partner at Booz & Company. Based on the latest survey conducted by Booz & Company, while the financial crisis has jolted the private banking industry, three fundamental characteristics of the industry remain intact: 1. Fundamentally geared for growth While world wealth generally expands at the rate of GDP growth, the number of high-net-worth individuals (HNWIs), defined as people with more than $1 million in investable assets, has been growing at anywhere from 1.5 to three times the rate of GDP. The increase in HNWIs is creating substantial wealth. The financial crisis of 2008 took its toll on HNWIs as massive devaluations hit all major asset categories and geographies. “But as economies around the world rebound, the asset base of HNWIs will return to its long-term growth trajectory, generating a steady flow of net new assets for the private banking segment, especially in Asia and Middle East,” said Dr. Daniel Diemers, a principal at Booz & Company. 2. Cyclical in nature There is no question that the revenue of private banks is highly correlated with the performance of equity markets. This cyclicality is no surprise; revenue in private banking depends heavily on transaction volumes and asset-based fees. As a change appears unlikely for the industry's revenue-generating model, this correlation likely will hold. For the near term, that means the industry's revenues will depend on the extent to which the markets can continue the rally they started in March 2009. 3. Profitable even in difficult times Since the beginning of this financial crisis, the wealth management industry has lost 25 to 30 per cent of its revenue because of a lower asset base, cautious market behaviour, and a shift toward low-margin financial products. Yet more than 95 per cent of private banks analyzed worldwide were able to deliver positive pretax profits during this period. Private banks' persistent profitability is a reflection of the speed at which they can adjust their operating models to align them with current business conditions. While the underlying dynamics are fundamentally promising for private banks, the industry must navigate through a number of significant changes going forward, like tectonic shift in global wealth distribution. “While the majority of industrialized countries are just beginning to recover from the financial crisis, most emerging markets have already returned to pre-crisis growth rates,” said Vayanos. “We believe that these varying rates of recovery will persist for the next few years, shifting the global wealth concentration to the East.” Middle East and African countries will likely return to accelerated wealth creation even before the global economy fully recovers. Large government-led infrastructure projects will further boost the regional economies and many HNW and UHNW clients will benefit either directly or indirectly from these projects, the survey said. The Asia/Pacific region, led by China and India, will be where most new HNWIs will be created, driven by the strength of the underlying economies and a strong entrepreneurial spirit. By the end of 2011, nearly 3.6 million HNWIs are expected to live in the Asia/Pacific region, up from 2.57 million in 2008. In Europe, GDP growth rates for key markets are expected to remain flat for the next few years. A significant shift of assets among European countries is likely, due to the new regulatory regimes. North America continues to hold a significant share of the world's HNWIs and UHNWIs (ultra-high-net-worth individuals). Slow growth in productivity and in North America's economies is expected over the short to medium term, limiting the overall growth in asset markets and in the number of wealthy households. Many emerging-market countries are also expected to become more politically stable and thus offer good investment opportunities. This will create another disincentive to bring the new wealth offshore. The survey urged serious commitment to emerging markets. The expansion and evolving behavior of the HNWI population in China, India, and the Middle East will require private banks to operate in new ways in these markets. Wealth management players with global ambitions need an emerging market strategy to capture the large wealth expected to be generated in these regions in the coming years. They will also need to acquire or develop a deep understanding of, and access to, local investment opportunities as new wealth is increasingly invested locally.
