Strategy

Swiss private banks overhaul business models to survive, retain clients

A staff reporter, September 18, 2002

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Bull markets buoyed Swiss banks for so long that no one thought to take a closer look at the underlying business structures that some say ne...

Bull markets buoyed Swiss banks for so long that no one thought to take a closer look at the underlying business structures that some say need overhauling. Profits are down for a second year but local private banks are beginning to remould themselves into a more modern, competitive version of their former selves, each in its own way.

Gone are the days when private banking was a straightforward business. With growing IT costs, regulatory pressure and the need for costly due diligence operations, the cost is skyrocketing.

"Private banking used to be different: you didn't need a lot of capital, return on equity was great. It was pretty much a risk-free business. But now banks are required to look carefully at IT investment, especially in the front office, and broad due diligence as the reputation and brand are otherwise at risk. It's evolved from being something fairly straightforward to something complex. Clients are more complicated — more sophisticated too — and some players may not be equipped to handle the complexity," said Philippe Theytaz, partner at PwC Consulting in Geneva.

Some banks see their salvation in embracing elements of the US model while maintaining a traditional style — the hallmark of which is confidentiality and continuity.

UBS' acquisition of US broker PaineWebber perhaps epitomises this fusion of relationship-oriented Swiss private banking culture with the US-style sales and product-oriented approach.

Stefan Erik von Euw, of Banca del Gottardo, said "open architecture" — a system under which clients offer third-party products alongside in-house wares — was vital.

"We need to focus on key competence and strengths. We must act in the best interests of the client and ensure our clients are best-advised and one of the first steps is open architecture," von Euw said.

The American "client-advocacy approach" is catching on, but von Euw said, unlike their US counterparts, Swiss private banks have not yet moved to the next stage: account aggregation, where one bank provides an IT platform to group all the clients' accounts and investments. Often this is done with other banks, under one roof, with the bank acting primarily as adviser and manager selector.

Banks are already downsizing, sharing or outsourcing back office, IT and due diligence operations. Yet analysts and some bankers agree that if they are serious about survival, they will have to tackle the last taboo: asset management.

There is considerable resistance to the idea. Many like Jean Bonna, partner at newly-created Lombard Odier Darier Hentsch, still believe this is integral: "When asset management, our main activity, is a great asset not just a divisive structure, it will be profitable".

Asset management was once virtually synonymous with private banking, but a growing number of bankers believe it is no longer a must and say you can't be good at everything.

"Many banks still feel they have to manage assets in-house," von Euw said.

"But we need to move toward a family office approach, where the bank does the strategic asset allocation and manager selection and its role is more that of a strategic consultant monitoring performance and quality of services".

Similar to the family office philosophy, this also involves taking a more holistic approach by taking clients' whole financial situation into account when making any single investment or other financial decision. Client segmentation is also seen as key to creating a more competitive business structure.

Ian Ewart, head of global communications for HSBC Republic, said that when the global banking giant took over Edmond Safra's Republic National Bank, part of the integration process involved separating the private banking clients from the affluents.

More and more private bankers say they are beginning to realise they can no longer treat all clients the same and that it is unfair to lump high-net-worth clients together with mass affluent clients.

Bankers and analysts say pricing must change, as banks realise they can reduce volatility of returns by shifting from transaction-based fees to performance and advisory-related charges.

Ray Soudah, founder of Millenium Associates in Zurich, the M&A private bank consultancy, said this was one reason why banks were advising clients to invest in more sophisticated products, such as hedge funds and other alternative investments, that perform and with higher returns.

"There is a certain amount of encouragement for clients to go into products with better expectations, it's partly to get better fees and higher performance.

The bank's dividend is twofold: by acting as intermediary for third-party funds and from performance based fees," Soudah said.

He said Switzerland's partnership private banks, which dwindled this year from 17 to 14 through mergers, might only survive if they convert into limited companies.

Soudah said the value of these banks was "considerably lower" than those of a similar size but different form because of their "inefficient structure" and the risks associated with acquiring a bank in which partners take unlimited liability.

"It's not easy and the market would undervalue them because of the risk," Soudah said.

Bonna argued the advantage of running a partnership of unlimited liability is that you do not take undue risks and that strengths still outweighed the weaknesses. He admitted, however, that these might be dying out.

"It's true that the partnership bank is a dwindling species and has become typically Swiss," Bonna said.

He also argued that privately-owned banks, which are under no obligation to publish their results, are free to pursue longer term strategies than listed banks, which are under shareholder pressure to perform in the short-term and that the manager-owner duplication made for a dynamic model capable of prompt and resolute decisions.

"It's a tradition. We've really created an identity for private bankers. It's not costs — it's the margin that counts. It's a legal form that needs high profitability. We have to be profitable," Bonna said.

"I think it's a form which is going to survive, but a form where you have succession problems".

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