As a merger wave sweeps the private banking landscape in Asia, the spate of consolidation has created ripples of concern as well as opportunities for players in the industry. Caroline Ng and Sruti Rao investigates the drivers behind the trend and its impacts.
A deluge of deals for global wealth management is foretelling a renewed consolidation wave amid stiffer regulation, margin pressures and tighter competition. More than 40% of all assets acquired since 2008 exchanged hands last year, according to the latest Scorpio DealTracker.
How well do you really know your competitors?
Access the most comprehensive Company Profiles on the market, powered by GlobalData. Save hours of research. Gain competitive edge.
Thank you!
Your download email will arrive shortly
Not ready to buy yet? Download a free sample
We are confident about the unique quality of our Company Profiles. However, we want you to make the most beneficial decision for your business, so we offer a free sample that you can download by submitting the below form
By GlobalDataWhile Asia is expected to power global wealth over coming decades, the region has also one of the worst cost-income ratios for private banks in the world, making profitability a growing challenge for the industry.
"The economics of the private banking model in Asia are brutal and very tough," says Sebastian Dovey, managing partner at wealth consultancy, Scorpio Partnership. "The cost-income ratios in Asia are the worst that private banks would have on a global basis so they are making less money there than in other markets."
According to a PwC survey, cost-income ratio of private banks in Singapore and Hong Kong is among the highest in the world, standing at an average of 83% in 2012. This bodes well with paltry revenue in Asia found by Accenture. Asia earned $600,000 in annual revenue compared to $1.1 million in North America and $1.3m in Europe.
Given that Hong Kong and Singapore have a combined ultra-high-net-worth (UHNW) wealth of $690billion, just under Switzerland’s $750bn, many private banks were lured to the glowing prospects and have established branches to tap burgeoning wealth in Asia.
"Many international banks have committed into a strategy to grow in Asia that dates back to at least 2008, but they had at least four years of either thin or no profit margin," says Dovey.
Although Asia Pacific is home to one of the largest number of growing high-net-worth-individuals (HNWIs), rising wealth does not equate to profit for private banks as the bulk of wealth consists of real estate and small business appreciation which are non-bankable assets. Drilling further, such asset price appreciation has created many millionaires in the region. However, the newly affluent may not be the target market for a private bank.
"In 1980, the definition of a private banking client was someone who had a million dollars," says Bassam Salem, chief executive of Citi Private Bank Asia Pacific. "30 years on, with inflation and the depreciation of value of the dollar, a minimum of $10m is needed to be a Citi Private Bank client."
In reality, UHNWIs account for just 0.7% of Asia-Pacific’s HNWI population, representing about a quarter of total wealth. The rest is occupied by ‘millionaires next door’ with half of the total segment wealth, a report by Capgemini and Canada’s RBC Wealth Management found. This means many clients actually belong to the affluent spectrum not necessarily targeted by private banks.
Furthermore, overheads including rents and salaries for wealth managers are much higher in Asia than the global average.
"Some private banks run a very expensive platform and their clients are at the low end of the net worth spectrum," says Salem. "As a result, their cost-income ratio is between 80 to 100 and even negative as some are losing money."
Finding no consolation from high costs and paltry pay-offs, many private banks are starting to question if remaining in Asia is worthwhile.
Margin pressures
Meanwhile, the swelling cost of regulatory compliance is a major game-changer for the private banking industry as it has substantially damaged the bottom-line.
"Regulatory costs are an unexpected charge which banks haven’t previously planned for and are often the tipping point between holding on or finding a new partner," says Dovey.
With regulators ushering a fervent push to end banking secrecy, Asia no longer enjoy the same status of favourable tax breaks as previously undeclared assets come under scrutiny. The stiffer universal capital requirement is also hurting balance-sheets and foreign banks may start shifting the focus back to their home region where core assets are.
Besides regulatory expenses, banks are projected to invest significantly in technology. Although only a fifth of banks currently use mobile technology, PwC expects all banks to adopt the technology by next year. Against the backdrop of high costs, profit margins are further squeezed as Asian customers tend to be price-sensitive with advisory fees as well as having many private bankers.
Prospects for further decline in revenue growth in Hong Kong and Singapore private banks have added to the woes of margin pressures. According to PwC, revenue has fallen from 32% in 2012 to 23% last year and is projected to fall further to 21% this year.
Critical mass
With the measure of standard pricing in private banking largely based on assets under management, achieving a critical mass is becoming increasingly important to boost profitability.
The top 20 wealth managers not only command more than three-quarters of total assets but have further gained around 11% market share in 2012.
"The largest 20 global private banks are all running in 20 % margin growth," says Dovey. "Beyond the top 20, the margin becomes much more challenged so there is a big push by businesses outside the premier league to increase scale."
As the costs and complexity of compliance continue to cascade and push smaller operators to the edge due to the lack of scale, larger firms are better positioned to defend their ground. Market leaders will eventually emerge as the biggest winners, having able to contain rising costs and risk-management demands, the World Wealth Report 2013 found.
Tiny boutique firms may even just quietly exit the market given that their assets are too small to attract any buyers.
"In the private banking industry, shareholders have an alternative. If the cost-income ratio does not adjust then the shareholders will decide to exit," says Salem.
Low valuations
According to Scorpio, valuations have dipped to record lows to 1.22%, indicating a more realistic price and opportunity for private banks to acquire complementing expertise.
"Lower valuations reflect the view of investors that the medium to long term prospects for growth are less rosy than they were 10 years ago," says Jim Antos, analyst at Mizuho Securities Asia. "They also reflect the concerns investors have about the need for banks in Asia and globally to increase their capital base and to pay significantly higher regulatory costs."
Despite low valuations, assets acquisition in Asia is still considered relatively more expensive than other mature markets. Although prices might have to fall further to spur deal-makings, Asia has cemented itself as a hotbed for mergers and acquisitions activity, a recent research from Cass Business School found.
"The rise of Asia for M&A is underpinned by a favourable regulatory landscape and a maturing market," says Anna Faelten, deputy director at Cass Business School.
Another significant trend is financial services managed to be the only industry where globalization appears to be retracting.
"In all other industries, companies want to diversify and enter new markets," says Faelten. "But financial services have been on a contradicting trend where foreign banks have pulled out a lot of their investment in other markets, particularly in Asia, and returned to their domestic market."
Such is the case where France’s second-largest listed bank Societe Generale is seeking to sell its Asian private bank which manages about $13bn in assets late last year.
Changing practices
The integral topic of scalability and determining the right strategy towards asset accumulation invariably holds different schools of thought among different players. Larger firms believe that although it is hard to put a ‘magic number’ on the ideal size of assets under management, they are of the consensus that scalability is required to deal with current cost pressures.
"The control agenda has changed significantly for wealth management operations over the last several years," says Peter Flavel, chief executive of J.P. Morgan Private Wealth Management Asia. "It remains at the forefront of running a private bank well, but that has costs associated with it. That is where some of the challenges lie for the smaller players. So I do believe that the size at which banks need to operate is important to have the scale to implement these necessary controls has increased and that could have a consolidation effect in Asia."
ABN AMRO Private Banking’s chief executive of Asia and Middle East reinforces the need for scalability by highlighting the factors that are causing consolidation in the region. Hugues Delcourt explains: "Private banking is an expensive hobby as we all know with the high cost-to-income ratios, especially for players who are subscale. Secondly, talent is scarce in the region and what is scarce is usually expensive, hence they command fair compensation. Thirdly, Asian clients are getting more sophisticated. They are expecting more developed product and service platforms that require money to build. It is these three parameters that make private banking a high cost business so scale is needed to survive."
Despite the apparent need for scale, smaller wealth management firms claim profitability in the region.
Evard Bordier, chief executive of Bordier and Cie said that their sustainability stems from the strength of their client relationship.
Bordier defends: "We are profitable, and obviously my vision of profitability will be different from a big bank’s vision of profitability. I am doing my business for the next generation with a longer-term view."
"To me, people merge in Asia is because they may just not be interested in the market, as it makes up a very small part of their business. The other reason is that I have overrun my cost, losing money year after year and so let us merge with a bigger player to become more efficient."
In response to the evasive question of handling industry-wide compliance costs, Bordier candidly reasons that the firm looks to third party agents to expand its reach and efficiency.
"Today private banking is not about doing everything in-house, it is about partnership. The client should not come first, but rather, we should be a partner to the client. I have to partner with people to offer the broad range of investment banking capabilities, to offer the best of service available in the market to our clients."
Asia prospects
Although Asia remains important as a region, the wealth management industry is currently in a flux with its significance being constantly re-evaluated.
Delcourt of ABN AMRO says: "It is no longer a complete taboo to enter a boardroom and say we should leave Asia. This would not have been the case a couple of years ago."
Despite the prospect of cost-cutting reassessments and major restructuring, the region should remain integral to the growth strategy of global banks, concurs the industry.
Flavel clarifies: "For banks seeking to be global, it is going to remain the norm to have Asian operations. I don’t think the question is of exit for most of the players, the question is more on how are they going to ensure that they are efficient in their costs, and the deep relationship they need with clients to grow their revenue line is maintained."
However, based on a welter of research and industry experts, the pace of consolidation is expected to remain high this year driven by banks who fail to weather the regulatory storm.
"For some, Asia may not be the pot of gold that lies at the end of the rainbow. We expect further consolidation in Asia’s private banking sector. This should benefit the big boys as they have the financial muscle to make the business profitable and pick up potential bargains along the way," says to Jek Lim, Partner, Financial Services at KPMG Singapore.
