The future growth of the private banking industry lies in emerging economies, a new study by Booz & Companyon showed on Thursday. Although rising wealth in China, India and the Middle East offers new growth opportunities, the industry today faces a transformed marketplace in the wake of the global recession. Private banks need to follow this flow of wealth, while adapting their business models to increased client scrutiny and new global financial regulations. The report, “ Private Banking after the Perfect Storm” forecast that by the end of 2011, almost one-third of the world's high-net-worth individuals (defined as having greater than $1 million in investible assets) will reside in the Asia/Pacific region - surpassing North America as the world's dominant wealth region (33 percent compared to 30 percent). Nearly 3.6 million of the global high-net-worth individuals are expected to live in the Asia/Pacific region, up from 2.6 million in 2008. The study also concludes that for the next few years emerging markets will lead the industrialized world in returning to pre-crisis growth rates. Further, most of the executives surveyed expect emerging market countries to become more politically stable, which will encourage high-net-worth individuals in these markets to keep their newly created wealth increasingly onshore. “Private banks with an ambition to grow need to seriously commit to emerging markets,” said John Rolander, partner at Booz & Company. “China, India, and the Middle East are emerging as new wealth centers, in a tectonic shift in global wealth distribution.” Private banks have proven to be highly resilient, even when hit with the “perfect storm” of a lower asset base, cautious market behavior, and a shift toward low-margin financial products. Although private banking revenues dropped 25 percent to 30 percent in the 18-month period studied, the vast majority of private banks surveyed still reported a pretax profit. Still, the recent recession has created formidable challenges for the industry, and the majority of the interviewees believe that the face of private banking has been altered irrevocably in the last 18 months. The study indicated that clients will behave much more conservative in future, reiterated by the fact that, despite a strong market recovery since March 2009, client have kept cash levels at stellar heights while further reducing assets managed in “discretionary mandates.” Client expectations will put the integrated private banking model itself under the microscope, according to the report. Today there is a mistrust toward integrated players that combine product production and distribution under one roof without a fully transparent approach to product portfolio management, the report said. In response, some institutions have already taken steps to separate their asset management business from their distribution arms, and others are likely to follow. Almost 90 percent of respondents say that the trend toward true open product architecture - where clients are offered the best financial products from top suppliers in every asset class - is the wave of the future. Moreover, a crackdown on undeclared assets is forcing offshore private banks to come up with new value propositions. Faced with increased scrutiny of offshore accounts by tax authorities, especially those of G20 countries, private investors have started to repatriate undeclared offshore funds. Offshore private banks will need to create new strategies to play in a “declared world” and private banks heavily dependent on un-declared assets might find themselves without a viable business model sooner rather than later. Private banks turned to cost-cutting measures to remain profitable during the downturn, the report added. All respondents reported reductions in variable pay and cuts to travel and entertainment, the Booz & Company study found, and 85 percent made selective staff cuts. Still, the report finds that further steps will be required in response to enduring pressure on margins and increasing cost for compliance. Private banks will need to find new ways to further lower their cost base beyond the 10 percent -15 percent that were readily available across the board. Strategies that focus on developing differentiated capabilities will help institutions to cut costs further without compromising their priorities. “We found that private banks reacted to the deteriorating economic conditions with impressive speed and flexibility - the myth that private banking is stodgy and overly bureaucratic just isn't true,” said Alan Gemes, senior partner at Booz & Company. “Firms aggressively cut costs, laid off low performers, downsized IT portfolios and withdrew from unprofitable markets.” While long-term prospects for the private banking industry are distinctly positive, private banks need to adapt their business models to the new realities. Emerging markets, led by China, India, and the Middle East, will be the main sources of wealth generation in coming years. With fundamental private banking needs in these regions underserved today, private banks should be looking for ways to penetrate these markets even more systematically than in the past. Private banking that relies on tax breaks is becoming a thing of the past. The transition will be painful for many clients, and private banks need to help. In particular, offshore players need to strive for full cross-border compliance while preparing for a time when they are able to offer onshore services. Different client segments have sharply different needs. Private banks need to adopt new client service models to regain client trust while ensuring compliance and cost-efficient servicing. “Advisory”, “Best-in-class product sourcing”, “risk management” and “wealth structuring” are critical capabilities which private banks need to further strengthen. The ongoing pressure on margins will make it necessary to get costs down along the entire value chain. Besides the measures already taken, a more rigorous approach will be needed to restore client profitability. All the changes taking place will set the stage for consolidation. Smart private banks will use M&A to build scale and to add critical capabilities.
