Our recent PwC Swiss private banking market updates (see here for the 2022 update) found that larger private banks were better able than their smaller counterparts when it came to generating attractive returns on equity (RoE).
However, our analysis showed that a few smaller private banks were also able to achieve comparable levels of financial success. We’ve taken a closer look at the business models adopted by these smaller players to be successful, also in a challenging market, and achieve similar RoE to their larger competitors despite the assumed disadvantage in size.
Financial performance – Median return on equity
Comprehensive but detailed survey
We sent an identical questionnaire to Swiss and Liechtenstein private banks with less than CHF 30 billion in assets under management (AuM). They were asked 20 key questions covering the core pillars of their business model and their operational set-up. The 32 respondents were subsequently grouped into three buckets (Top 5, Medium performers and Low 5 performers) based on the publicly available financial results for 2019 to 2021. The financial results of these 32 institutions were additionally compared with the results achieved by the large, Swiss-based private banks (>CHF 50 billion AuM).
Key findings
Our sample analysis reveals that the Top 5 performers consistently outpaced their peers from 2019 to 2021. They set themselves apart from the other two surveyed cohorts, which struggled to achieve robust RoE figures. Notably, the Top 5 group demonstrated an impressive ability to increase returns, even in challenging market conditions such as those experienced in 2020.
Institutions with a focus on private banking typically have complex and multifaceted business models with numerous levers for adjustment. Our analysis shows that banks of different sizes succeed by focusing on different levers. The Top 5 and large private banks achieve superior RoE figures by operating on an efficient cost base. The reasons behind this efficiency vary. Besides strategic direction, large banks achieve economies of scale thanks to their sheer size and large AuM base. However, some smaller banks compensate for the size disadvantage with a smart combination of business strategy components and the right kind of operational set up.
The two primary drivers of private banks’ RoE are operating income and operating expense (OPEX). These key determinants are primarily influenced by business model components and strategic market positioning decisions. The equity capitalisation in relation to the business volume (AuM plus loans) is similar among the different banks analysed (only a few, distinctively over-capitalised private banks) and therefore does not make a huge difference.
In terms of operating expenses (in basis points of average AuM), the Top 5 exhibit notably lower OPEX margins from a median standpoint compared with peers of similar size. Only large private banks come close to matching the low OPEX margins of the Top 5. At private banks, personnel expenses are the primary drivers of OPEX, while G&A and IT expenses have a relatively lower impact but can still vary considerably. This means that strategic decisions on the operational landscape as well as personnel set-up and compensation structure can heavily influence OPEX and ultimately impact RoE.
Interestingly, both Top 5 and large private banks have consistently reported lower operating income margins in terms of AuM compared with their smaller peers. This development is primarily driven by their focus on specific income streams. The predominant reliance on few income streams with increasing specialisation can lead to significant cost base efficiencies.
The Top 5 cohort places greater emphasis on net fee and commission income (NFCI) than the remaining peers of similar size. Banks outside the Top 5 banks rely more heavily on net interest income and other forms of revenue by comparison with the Top 5 banks, which seem to focus more on core private banking activities.
The top-performing group also displays a lower ratio of deposits to AuM than the low-performing banks, which may explain the higher proportion of net fees and commission income (NFCI) observed in the Top 5 group.
How do smaller private banks outperform?
On the basis of our survey we’ve identified four key business model levers used by the successful smaller banks:
- Product offering
- Clientele
- Personnel structure
- Operational landscape
Product offering
The Top 5 banks have a clear and focused product strategy with a narrow product portfolio that mainly relies on core investment instruments. This helps them achieve better financial results by reducing overhead costs, complexity and product development expenses. Other banks offering a wider product range can close the gap in profitability by controlling costs and streamlining processes.
Top performers focus on individualising client portfolios, tailoring them to specific needs and investment objectives. This contributes to the bottom line, builds strong client relationships and attracts new clients through positive word-of-mouth endorsement.
The most important asset classes offered by the Top 5 banks are traditional asset classes such as equities and bonds. Other banking groups have a more diverse asset class, offering additional asset classes such as alternative investments as well as structured products or derivatives. It’s interesting to note that the Top 5 primarily put together the client’s portfolio individually, whereas medium and low-performing banks follow a standardised approach.
“Size does matter in private banking, but smaller players can still operate highly successfully by making smart decisions on their products, target clientele, personnel and operational landscape.”
Clientele
“Swissness” continues to be an important selling point for private banks, with respondents emphasising the importance of trust and loyalty as well as a focus on domestically domiciled clients. The survey suggests that client retention should be based on sound factors such as expertise, reputation and customised services rather than preferential conditions.
Our research suggests that the ideal clients that smaller private banks should be focusing on are high-net-worth individuals with investable assets of around CHF 1 million to 5 million.
Banks outside the Top 5 lack a clear focus on targeted client segments, which can lead to pricing discounts and negative impacts on bottom-line results. A stronger focus on institutional clients among medium and low performers may negatively affect profitability because of higher volumes at lower fees.
“Size does matter in private banking, but smaller players can still operate highly successfully by making smart decisions on their products, target clientele, personnel and operational landscape.”
Personnel structure
Private banking has always been a relationship-driven business. It’s therefore not surprising that personnel expenses usually account for the highest share in the context of operating expenses. While such personnel costs can be significant, they are also an essential investment in the success of a private bank.
Private banks need to strike the right balance between personnel costs and other expenses based on their business model and strategy. Some may invest in personnel to differentiate themselves, while others may prioritise technology.
It’s key to create an environment that attracts and retains talented relationship managers to drive growth and build a strong brand. To achieve this, the compensation package must align with strategic objectives and incentivise relationship managers with variable compensation. However, it’s also important to make sure that the bank’s values are given the utmost significance in daily operations.
“Size does matter in private banking, but smaller players can still operate highly successfully by making smart decisions on their products, target clientele, personnel and operational landscape.”
Operational landscape
A well-designed operational landscape supported by a flexible and state-of-the-art IT platform can help a private bank to manage its costs and optimise its operations. Outsourcing business processes that don’t help differentiate a private bank from its peers is an effective way to enhance the efficiency and effectiveness of its operations, particularly for the smaller banks in our sample. Outsourcing decisions should be made on a case-by-case basis, considering the benefits of specialised skills and resources versus in-house processes.
Upgrading to more advanced banking software can improve operational efficiency, although banks tend not to change their software frequently.
Physical presence remains crucial for private banking, with the hybrid model not yet playing a critical role. Top 5 banks with lower AuM volumes sometimes operate at a single location with no digital offering. To be able to make informed decisions before expanding domestically or abroad, private banks should conduct a comprehensive analysis of market opportunity, competition and product decisions.
“Size does matter in private banking, but smaller players can still operate highly successfully by making smart decisions on their products, target clientele, personnel and operational landscape.”
