The business model
“Trust me I’m your private banker”, Oliver Wyman December 2009
A conflict free service,
except with the clients economic interest
A Private banking / wealthmanagement / asset management is a simple business model:
AuM x marginal – costs = profit
AuM is increased by actively acquiring customers. Costs are controlled by limiting the number of expensive private banks. At the same time, the management of customers’ funds is centralized on a few employees.
Private banking has been on the agenda of all banks for the past 10 years because the legislation has made many other banking activities too expensive for the banks. Private banking does not put any strain on the banks own capital.
What remains is the margin. Since the introduction of MiFID 2 in 2018, margins have been under tremendous pressure. It has become illegal for the banks to charge a fee for transferring customers to a Portfolio management (PM) service, which then invested a large part of the funds in own products. In addition, also carried out all transactions with the banks’ own market departments. Funnily enough, the demand for transparency regarding all – ALL costs has put a lot of pressure on customers. Just as the EU Commission wanted it.
Could it then be an idea to try to get the customers to invest some more money when the “investment specialists” deliver a good investment result? This solution should be right up your alley, but we do not know of any private banking or wealth management unit that distributes bonuses of any meaningful size to the specialists when they have a good year.
In general, the size of the bonus has been determined by the individual employee’s contribution to the bottom line. So when no internal bonus is paid for a good investment result, then one can conclude that the customer return is not a significant parameter. That customers’ returns are not important to the margin.
As a consequence, banks have neither incentive structures nor even resources set aside for good financial performance for customers.
There are (at least) two good reasons for this:
- To get a good return, one must take risk. Risk means that you also have a higher probability of losing money. So where customers (and perhaps investment specialists) see the opportunity for profit, the banks’ managements see an increased opportunity for loss of earnings (marginal) and loss of customers (AuM). In a time of margins under pressure, losses are not desired. And as all banks, therefore, invest clients’ assets in the same fashion, clients tend not to migrate.
In other words, the motivational structure of Private banking is;
“You rarely lose a customer due to a poor return – other private banks have the same poor returns.
To the banking business model, it is far too risky to try to attract new customers by delivering a stable return, created by avoiding large price declines”.
- All private banking operations collect information from their customers. Typically, they share customers with at least one other private banking entity. An experienced account manager always knows what his customers have achieved with the competition, and this knowledge seeps upwards and aggregates. So everyone measures up against the competition. Performance is only a problem if one’s customers have a significantly lower return than what the competitors have achieved. So knowledge gathering plus reluctance to take risks means that everyone has pretty much the same return. At least on the securities part of the portfolio.
If customers doubt that the return has been good enough, then it is easier to explain away when you never quite clearly tell which benchmark to compare with.
Alternative investments have been manna from heaven since around 2010: They may only be sold to customers who can be characterized as “professional customers”. Thus, the products fall outside MiFID 2’s rules on investor protection.
This means that there is no requirement for transparency regarding costs or risk. Nor is a benchmark required to be published. But in other words, customers are never told if it was a good investment. On the other hand, it is not uncommon for the bank to earn 2-3 percent per year during the life of the project.
With all this misery, why do private banking operations have customers at all? Because account managers have an important social skill: to make customers feel taken care of and to feel safe.
Overview of the investment competences within a bank