Sep. 20, 2010
In a recent editiorial article the leading Swiss business newspaper NZZ marks the incredible shrinking of Private Banking profit margins. One needs to appreciate that private banking profits in Switzerland have been among the fattest worldwide, reaching up to 5% of invested assets (in terms of gross margin). Private banking fees are typically in the range of 1% to 2% and hidden product fees, often adding another 1.5% to 3% to the bill for the client, have made private banking a more than attractive business.
The NZZ blames the downward pressure on private banking margins mainly on the declining contribution of offshore private banking, which is increasingly under fire from tax authorities around the world. As many clients are switching from an offshore to an onshore strategy, they are not prepared to keep on paying exorbitant fees and demand demands for private banking fee reductions are a consequence.
Private banking margins suffer from many factors
Yet it is not only Swiss private banks who are feeling the heat from clients. The private banking industry across the globe is having to cope with profound structural changes:
- Clients are becoming more pushy about private banking costs and services,
- global expansion is a costly game,
- regulators demand more extensive compliance with a host of new regulations and, last but not least,
- the new generation of financial products, ETFs or index funds, are gaining market share but are carrying lower fees and no commission.
In a recent survey MyPrivateBanking research found that more than 40% of German private banking clients are considering switching their provider. To counteract their calamities in the European markets many private banks have therefore declared Asia the future hope for wealth managers. Julius Bär group and Bank Sarasin have, for instance, declared Asia to be their second home market. In a new gold rush banks have been setting up infrastructure and chasing new employees, mainly across China, India, and Singapore. As a result the average salary of a private banking advisor in this regions has increased by more than 80% over the last three years. The costs of private banking going global are going through the roof, especially in Asia, stirring doubts that the banks’ expansion plans will generate profitable growth. It’s more likely that we will see a long and costly fight for market share across the globe, leaving only the biggest or the most focused players in strong positions.
Regulation is increasing private banking cost substantially
Another set of factors which contribute to margin pressures in private banking are the exploding cost of regulatory affairs. There are several initiatives originating with the European Union or the US government which have already increased costs for regulatory compliance a lot. And a new wave of regulation is looming already. One example is the FATCA (Foreign Account Tax Compliance Act) initiative of the United States. This law requires not only foreign banks but also other financial institutions (mutual funds, hedge funds, insurance companies, trusts and many others) to disclose all US account holders to the IRS (US tax authority). US account holders are defined as not only US citizens with a foreign bank account but all those designated as US persons, for instance temporary US residents who were holders of a green card at some point. If the financial institutions fail to disclose US persons they face a punitive 30% withholding tax on all financial proceeds from the US such as interest and dividends, but also including, for example, the repayment of the principal of a bond or other securities. Many large banks, particularly those with subsidiaries in the US, will be forced to comply. The effort of complying with the new law will no doubt be significant, as banks have to identify not only actual US citizens but also potential US persons who are minority shareholders of trusts and similar vehicles (the act applies to stakes of 10% or more).
Private banking clients demand new cost efficient products
Yet demanding clients, globalization and new regulation are not the only factors putting private banking’s profitability under pressure. A relatively new set of products called index funds or ETFs are gaining increased popularity with private clients. These products simply mirror different market indices and do not require active management by an asset manager. Unfortunately for the private banks, the sponsors of such index funds usually do not pay commissions or kick-backs to the distributing banks; instead sponsors of ETFs will point prospective purchasers to the relevant stock exchange. These products also carry much smaller internal fees, on average only 10% or 20% of the fees a regular mutual fund charges.
Overall, net margins in private banking will probably shrink by an average of one third over the next five to ten years if the industry is not able to respond with adequate rationalization and cost cutting. Only the largest player who can harness economies of scale across continents and very specialized value-adding boutique private banks will be able to profit from these structural changes. Private bank CEOs should think hard how their bank can become either one or the other.