Sustainable Private Banking Models in Asia
In the aftermath of the GFC, while activity in the Asian private banking industry remained robust with banks continuing to expand and new entrants entering the market, many had at that time observed that both the structure of the industry and economics were starting to show signs of unsustainability:
- Continued margin compression; from historical average of 70-80bps on AuM down to ~60+bps by 2012
- Rising costs; explicit and implicit costs especially in compliance
- Business models, fee model and RM compensation structures that seem to lend itself to conflicts of interest
Since then, the Asian private banking industry has seen a multitude of banks exiting the market.
Today, the challenging economics remain (continued margin compression with high compliance costs and expensive RMs, although overall operating costs seem to have stabilised), with fundamentally no massive changes to the structure of the industry. Banks still largely follow an integrated business model providing advisory, proprietary products and operations / execution under the same umbrella. RMs are still largely paid, either directly or indirectly, through product commissions.
What could sustainable models for Private Banking be going forward?
In our view, there seem to be three business models that have been sustainable and would likely still be going forward, if the banks in each model focus on their unique selling points and actively manage the inherent challenges: the “global universal private bank”; the “advisory-focused, trusted advisor private bank”; and the “domestic commercial bank-linked private bank”. A fourth model, the “digital-driven private bank”, may be the right model for new entrants to attack as a disruptor given advances in technology today.
1. Global universal Private Banks
These banks have the global reach and scope to serve as “one-stop shops” for HNWIs covering a comprehensive range of services from advisory, brokerage, capital markets and financing solutions to investment banking services. For these banks, the challenge will be in managing greater integration across the different parts of the bank to deliver a seamless proposition to their clients (oftentimes organisation and silo issues result in an inferior experience to the client), while at the same time actively managing the cost of complexities and conflicts of interest, both actual and perceived.
2. Advisory-focused Private Banks
These banks focus on being the independent trusted advisor to HNWIs, where a fee-based model is favoured. With the core being superior advice in the full interest of the client, these banks should consider being independent of any in-house asset manufacturing or proprietary investments to avoid any real or perceived conflicts of interest.
3. Domestic commercial bank-linked Private Banks
These banks typically start with onshore private banking services and, over time, in following their customers, expand to offshore centres in HK and/or Singapore. Their competitive advantage lies in leveraging their retail and corporate banking customer base for a steady pipeline of customers and existing banking platform for cost efficient operations, with home market advantages. These banks should be very focused on customer segments that are in line with their broader bank strategy and strengths e.g. business owners, local prominent family-owned conglomerates who already bank with them.
4. Digital-driven Private Bank
The time may be right to try a structurally different business model, especially for new entrants aiming to disrupt, that would have the following elements:
- Using AI to augment wealth and investment advisory, to the extent that the core of advice delivery (from risk profiling to investment strategy to portfolio allocation / rebalancing) is done by ‘robots’, leaving the Relationship Managers (RMs) to focus on what they do best, i.e. relationship management, dealing with the high touch service and emotional aspects of serving the customer
- On a similar vein, automating labour-intensive functions such as compliance and legal, with natural language processing technology and algorithms scouring public sources of information and being fed by various 3rd party data providers
- For cost efficiency, utility IT and operations are outsourced to 3rd party business process outsourcing (BPO) providers
- With banks moving away from having to compete and pay their RMs in the traditional way, innovative fee structures that are better aligned to customer needs can be applied
Use of AI for advisory
PBs today seem to be still built around the RM facing off with the client, with a whole host of in-house research, wealth planners and investment advisors supporting the RM to deliver advice to the client.
I read with humility the recent artificial intelligence program beating top human players at “No-Limit Texas Hold ‘Em”, crossing one more AI milestone – this one a game of psychology and less than perfect information. Incorporating these aspects of AI into robo-advisory type engines and tools will certainly put us closer to replicating the human investment expert. Furthermore, one can argue that the machine, free from biases and blind spots, will over the long run outperform the human advisor. There are already client segments today that say they will trust the robo- more than the human advisor.
Similar for areas like tax advisory, by combining natural language processing ability and big data in the future, robots can be used compute tax optimization pathways.
Automation of labour-intensive functions
For labour-intensive areas like legal and compliance, automating significant parts of the functions seems a real possibility in the not-too-distant future. For instance, JP Morgan’s COIN program reportedly has the capability to do the mind-numbing job of interpreting agreements utilising natural language processing technology. In compliance, algorithms than can process public, private and 3rd party data can be used to augment manual KYC checks. Here the challenge will be convincing the regulators that this indeed does not lower any responsibilities or burden of proof on the bank, but instead improves effectiveness.
Business Process Outsourcing (BPO)
BPO of commercial banking operations is a fairly well-established practice, but not so much in the realm of Private Banking, especially in Asia. However, as bottom line pressures increase and such 3rd party providers become more established (through our experience working with an increasing number of clients) this practice certainly makes sense for small to mid-sized banks, where the most basic of platform and processes that neither add any real value nor offer competitive differentiation are ripe for outsourcing. The banks are best left to focus their efforts on the front end.
Perhaps the biggest change in moving away from the traditional role of the RM and how they eventually get paid, is that the bank is ‘freer’ to explore different fee regimes. More importantly, this implies that fees can potentially be more aligned to customer’s ‘success’ (e.g. performance-based fee regimes), or even customer ‘satisfaction’ which ultimately translates into tangible measures such as steady increase in customer’s AuM with the bank. Without such a fundamental (re-) alignment of fees with measures of customer ‘value-added’, niggling customer doubts and reservations will always remain.