European private banks enjoyed higher deposit margins in 2022, which helped them weather a drop in revenues from invested assets and another increase in the cost of doing business. As a result, profitability (as measured by the cost-to-income ratio) trended sideways. Private banks desiring to accelerate structural profitability in 2023 and beyond can benefit from looking to the balance sheet, accelerating the industry’s push for recurring revenues, and spurring cost-effective growth, particularly through their relationship managers.
Those are some of the key findings from McKinsey’s 2023 survey of European private banks—the latest in a series we have conducted annually since 2003. We also reviewed the recent financial results of more than 100 institutions, gathering details that add to our understanding of the pressure banks are facing in 2023.
In this article, we describe the trends that have shaped the business of private banking in Europe, the position of the industry today, and our forecast of where it may be headed. We also sketch the moves that many successful private banks are making to get ahead of the trends.
State of the private banking industry
First, the good news. Industry profits in Europe rose 1.7 percent to €22 billion in 2022, a new peak driven by high assets under management (AUM) at the beginning of the year and a substantial rise in net interest margins (Exhibit 1). Interest margins on deposits rose 13 basis points (bps) and contributed nine bps to total private banking revenue margin in 2022, up from a contribution of just five bps the previous year.
However, all in all, AUM decreased 7 percent in 2022 from the previous year. The overall decrease reflects a 10 percent decline due to market performance and a one-point decrease in net inflows to 3 percent, versus 4 percent in 2021. The drop in AUM diminished much of the yield private banks made during the past five years, with banks’ individual results varying in response to many factors, such as asset allocation. Profit margin, at 22 bps, was flat; revenue and cost margins increased by one point year over year, reaching 71 and 49 bps, respectively.
After the 2021 cost hike, absolute cost growth slowed to an annual increase of three percentage points in 2022. However, the five-year trend of increases continued unabated, up 11 percentage points cumulatively between 2018 and 2022.
As costs mount, banks are under pressure to keep revenue growing. In that area, the results have been mixed. Revenue margin on invested assets declined by four bps in 2022 as a result of declines in brokerage revenue margin (down two points), recurring revenue margin (one point), and retrocession margin (one point). Clients divested and moved into cash, were less active in markets, and deleveraged their portfolios. At the same time, valuations fell for riskier investments like equities, affecting mandate revenues.
Compensating for this, the deposit margin increased from 17 to 30 bps (Exhibit 2). This change contributed an overall four-point increase in total revenue margin, considering the 30 percent share of cash in the total asset allocation of client AUM at private banks.
Ultimately, responses to the survey suggest the that the two-pillar business model of private banks was resilient in 2022 while investment-type products were less in favor with clients, the second pillar, deposit margins, strengthened. The resilience continued in the first half of 2023, according to most first-half results communicated.
However, the industry’s structural profitability net of interest rate effects has declined as costs increased further in 2022, revenue margin from invested assets dropped, and the tailwind in revenues from increasing AUM performance vanished. Further, as inflows slowed, most private banks struggled to attract new clients, leading many to hire new relationship managers at scale.
In addition, the industry needs to articulate its value proposition to clients: from 2018 to 2022, balanced risk profiles, the most common choice among clients, returns were zero or negative.
Future wealth growth
During the next three years, projected growth in personal financial assets will create more opportunities for private banks. We expect most growth to come from onshore, primarily in North America, Asia–Pacific excluding Japan, and Western Europe (Exhibit 3).
In terms of financial centers, Switzerland still leads, with Hong Kong and Singapore catching up quickly. Singapore shows the fastest growth, at 8 percent, which is double the rate of the top nine other private banking centers.
The increased opportunity from new wealth creation contrasts sharply with the potential development of wealth owned by high-net-worth (HNW) people. A new report from McKinsey Global Institute, The future of wealth and growth hangs in the balance, finds that global assets have almost doubled in value and decoupled from GDP development over the past two decades, but executives expect a potential reversal. In the two macroeconomic scenarios for 2030 that respondents deemed most likely, real client wealth could be at risk due primarily to a long-term reversal in equity and real estate prices.
Potential pathways to restore structural profitability
A clear challenge for private banks is to restore growth over the next 12 months and beyond. Leaders can consider several paths for the short term and a key action to boost long-term growth. Some of these might be familiar, but in our experience, they remain the most effective for revenue growth. given details on building resilience by means of cost optimization on many different occasions.
Options for action in the short term
In the short term, look to the balance sheet. Private banks can optimize both assets and liabilities. To get started, banks can run some technical optimization of foreign exchange and liquidity. For example, deposit pricing is often highly relevant. Banks can vary the interest rates they offer to clients based on factors such as their assets with the bank and likeliness to leave; or they can propose more restrictive terms for clients on withdrawing these deposits.
Then, to manage both lending and deposits, banks can focus on the following ideas:
- Look to loans. Private banks can increase lending penetration by converting more of the pre-authorized Lombard limits pledged by existing client collateral. Relationship managers (RMs) would need to work with clients to understand if they want to take out the remainder of already authorized loans.
- Help new relationship managers grow their client book. Several private banks have recently announced the hiring of new relationship managers (RMs). However, our survey results show that adding RMs does not necessarily result in commensurate revenue growth. The odds that RMs can succeed are greater when private banks actively manage their new hires by emphasizing practices associated with strong sales growth.
- Create new inflows. RMs can tap their client network for referrals and look harder for new prospects. To boost the former activity, leading banks are implementing at-scale referral programs. To achieve the latter, they search public information (e.g., media, commercial registries) to identify clusters of prospective clients for future net new money growth.
Options for the longer term
Over the longer term, banks can improve their margin on current AUM. As a first step, private banks can review their pricing and the level of service they offer. Our experience shows that proactively managing pricing is often more valuable than relying on automated pricing engines. Smaller HNW clients in particular deserve a second look. Banks can often lower their price for these customers while also automating the advice they receive. Banks can also ask RMs to upsell some client clusters, to deliver on customer preferences with respect to market volatility, environmental, social, and governance (ESG); and alternatives. Across all mandates, banks can look to expand share in higher-margin alternatives, such as structured products and private markets.
These sample pathways may help private banks increase their resilience for any of the macroeconomic scenarios we surveyed. As we cross the halfway mark of 2023, our survey suggests private banks have adapted to unforeseen shifts – but they will need to be just as nimble in the years ahead.
Sid Azad is a partner in McKinsey’s London office; Cristina Catania is a senior partner in the Milan office; and Marius Huber is an associate partner in the Zurich office, where Jan Quensel and Christian Zahn are partners.
The authors wish to thank Rashi Dhingra, Saksham Kalra, Ankit Khandelwal, Shaurya Khanna, and Marlitt Urnauer for their contributions to this article.
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