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European private banking: An inescapable call for action

New headwinds in a profitable market indicate the need for fundamental transformation.

Private banking has long been the most profitable sector in the global banking industry. Last year, the sector contributed a sizable 5 to 6 percent of profits with low capital requirements. Western Europe’s private-banking sector had enjoyed a run of high growth until mid-2018, supported by positive market performance. European private banking profits grew by an annual average of 6 percent in the five years before 2017. However, 2018 saw this run come to an end as profits shrank to €13.5 billion from the previous year’s €14.7 billion. Profit margins were down to 22 bps, a loss of 3 bps over previous year.

The absence of long-running financial-market tailwinds, and market deterioration in the fourth quarter, brought to the surface some of the structural challenges the industry has faced for a long time. Total assets managed by the industry fell by 4 percent in 2018. A rather steady 2 percent long-term rate of inflows was not enough to counterbalance a 6 percent fall in market performance. At the same time, revenue margins, which have also steadily declined for the last five years, fell to 75 bps in 2018—a loss of 6 bps since 2014. While European private banks have continued to take tactical measures to keep costs in check with revenue evolution, the absolute cost base has continued to grow 2 to 3 percent year on year. Together, these headwinds resulted in an 8 percent decline in absolute profits.

The 2018 performance further highlighted the benefit of scale in the industry. On average, small and midsize players have consistently underperformed. Over the last five years, profit margins of banks with total assets less than €10 billion per booking center fell to 1 bp from 7 bps in 2014. In contrast, profit margins of large banks (those with assets greater than €30 billion per booking center) grew to 40 bps from 39 bps in 2014. The benefit of scale, coupled with the fragmented nature of the industry, has meant that two-thirds of players have failed to improve profitability in the last five years.

Overall, these headwinds resulted in a rather challenging year and highlighted the need for fundamental transformation. The potential for a global slowdown adds to the urgency. Tactical measures like selective digitization of the service model or introduction of new investment themes (for example, ESG investing—environmental, social, and governance) may not be enough. Private banks will need to reconfigure their business model to operate in a market with flattening asset growth and ever-decreasing margins. In our full report, available for download below, we propose a three-part call to action for banks: 1. Double down on creating digitally enabled exceptional client experience, substantially improve front-office effectiveness, and consider new service value proposition models to drive growth; 2. Adopt a next-generation operating model that is akin to operating like a scalable technology platform—that is, automated and straight through with fully embedded mid- and back-office functions; 3. Benefit from structural shifts, including consolidation and sharing of costs, by creating or participating in industry utilities (for example, shareable technology platforms and mid- and back-office functions).

To download the full report, click the link below.

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