Investment and Private Banking - Essay Example

1. Introduction Private Banking and Wealth Management continue to be the growing business models, despite the setbacks suffered during the financial crisis in 2008-09: the setbacks have remained only temporary. Inspired by the Bull Run in stock market and expansionary wealth creation, private banking has been growing excellently over the past five years on a global level. During these years wealth managers have focused their attention on the large expansion of the market. Compared to other financial activities like investment banking or extension of credit to businesses and consumers, private banking and wealth management seem to be relatively ‘low risk’ activities although they are not completely independent of risks and market failures (PricewaterhouseCoopers, 2005; Scorpio Partnership, 2007). The wealth management activities have become diversified and even aggressive in recent years. Diversified investments and alternative technological innovations have exposed unusual opportunities and challenges to the wealth managers. With geographical diversification and competition for crucial grips, new markets have opened up. Mergers and acquisitions continue to force the wealth managers to stand either as super league contenders or niche boutique. The present paper consists of seven major sections including the present section of introduction followed by the conceptual discussion on private banking and wealth management. Third section focuses on mandate wealth management followed by the key drivers for wealth management. The driver of wealth management as economic growth is discussed in the fifth section while sixth section is dedicated to examine some examples of private banking institutions on the basis of ranking and scale. The case of Asian countries (as an example of economic growth as the driver of these institutions) is discussed in the seventh section followed by the section of concluding remarks. 2. The Concepts of Private Banking and Wealth Management The concept of Wealth Management refers to financial services provided (by whom- explain) to wealthy clients typically with $100000 and more investable assets. Private banking is a major and more exclusive subset of wealth management typically with $ 1million and more investable assets. Earlier, private banking was viewed as very exclusive and providing services to high net worth individuals with liquidity over $2 million, but now it is possible to open some private bank accounts with an amount of $250000 for private investors. The private banking division provides a variety of services such as wealth management, savings, inheritance and tax planning to their clients. The term ‘private banking’ refers to the financial services rendered by banks to private individuals investing substantial assets. The financial services include banking (deposit taking and payments), discretionary asset management, investment and like others and these services are provided on a more personal basis rather than in mass market retail banking. Private individuals are availing these services from the banks via dedicated bank advisors. The term private banking may be confused with the term ‘private bank’ which means a non-incorporated banking institution. The word ‘private’ in private banking is also a reference to the secrecy it offers under these types of services. Through careful investment, careful allocation of assets and/or by hiding assets from the taxing authorities the banks protect their clients from the burden of taxes or at least reduce it considerably. Swiss Bank and some other offshore banks have been criticized for cooperating with individuals’ practices of tax evasion. Though ‘Tax Fraud’ is a criminal offense in Switzerland, ‘tax evasion’ is only a civil offense and hence banks are not required to notify these to the taxing authorities or government. Such practices, it has often been criticized, sacrifices the collective interests of community for the sake of individual interests and functions as a stumbling block in the collection of money that could be invested in other welfare/developmental activities. Such services of secrecy and evasion of taxes can also encourage corruption beyond any limits. Wealth management refers to a high level form of private banking for the affluent individuals or groups of individuals. Wealth refers to wealth pools which are defined as financial assets except pension assets of High Net Worth Individuals (HNWI). It is an integrated process for helping clients to manage their wealth and it usually involves a diverse range of services in accordance with the needs of the investors. These needs include investment management, financial planning and evaluating options of investment. Financial planning includes helping to make optimal decisions, projecting the consequences of the decisions of the financial plan, and then comparing future performance against retirement or estate planning. Wealth management includes the overall planning regarding the disbursement and management of a person’s wealth, including the will preparation and planning of taxes. Tax planning includes formulation of strategies in order to minimize, and if possible to avoid, the tax liability. What is a firm and why is the difference between manager and firm is important The three criteria which differentiate a wealth manager from a firm are: First, the relationship that the managers have with their clients will have both breadth (in terms of its holistic and comprehensive nature) and depth (in terms of the intimacy and the ‘individualized nature of services). Second, the products and services provided by the firm will be with a particular emphasis on estate planning and multigenerational planning as well as advises on tax expertise and alternative investment (explain). Third, the specific objectives of wealthy clients will be like investment performance, preservation of wealth or transfer of wealth (explain). 3. Mandate of a Wealth Manager Like many other services wealth management also includes services that are mandatory and that are optional and left to the discretion of the clients. In addition to this the wealth management institutions are also authorized to perform specific functions for their clients. A wealth manager acts as the custodian for the clients’ assets which involves, mainly, asset safekeeping, income collection, fund disbursement and associated reporting. These institutions will have execution – only mandate in some cases. The wealth manager executes, or selects brokers to execute, transactions of securities on behalf of the client. Advisory mandate like tax advisory expertise and investment decisions and discretionary mandate are tenured by these institutions. The wealth manager has the discretionary mandate to buy and sell assets and execute transactions for client. 4. Main Drivers of Private Banking and Wealth Management While discussing on the drivers (what is meant by driver and driving factors) of private banking and wealth management, it is very essential to take a look at the types of wealth management on the basis of geographical situation. The type of wealth management is critical for deciding the driving factors of private banking. Geographically, there are two types of wealth management, i.e., onshore and offshore wealth management. Onshore wealth management is within the client’s country of residence while offshore management serves the clients who are in need of managing their wealth outside their country of residence. There could be several reasons that might require an individual to seek offshore wealth management services. It could be financial confidentiality, legal system flexibility, tax consideration, the lack of appropriate products and services onshore, a low level of trust in domestic financial markets and governments and the need for safety and geographical diversification. There are four key drivers for wealth management: 1. Economic growth:The wealth management activities are highly inspired and driven by the economic growth. While the economies are expanding, the volume of HNWIs will also increase, which, in turn results the high demand for wealth management services. 2. Asset prices: There exists a positive correlation between the price of assets and the private banking. That is, when the asset prices increase, the wealth management activities will also automatically increase. 3. Wealth allocation: Allocation of the wealth among the individuals is a critical determinant of wealth management. A more uneven and inequal allocation of wealth may lead to the concentration of wealth among few hands. That is, HNWIs will emerge and wealth management becomes essential. 4. Demographical factors: The age and like other demographic factors play crucial role in the wealth management activities. Economic development as well as economic stability of a country plays a crucial role in determining offshore as well as onshore wealth management. Offshore centers seek competitive advantages such as political and economic stability, excellent infrastructure, quality of life and favorable and effective legal and regulatory environments. Wealth allocation mainly drives onshore wealth management. It is calculated that nearly 10 percent of the global population hold around one third of the total wealth in the economy and those in the top 5 positions hold more than half of the total wealth. While this remains so, at the other end, more than 10 percent of the population has little or no assets (Cagetti and Mariacristina, 2005). Source: Merril Lynch / Cap Gemini World Wealth Report 2006 Likewise, demographic factors are also key drivers of onshore wealth management. There are regional differences in terms of the key wealth management drivers. The region wise differences of key drivers are summed up in the following table. Table.1 Regional Differences in the Drivers of Wealth Management Region Drivers of Wealth Management North America High Economic and productivity growth rates, strong US financial market returns, onshore holding of bulk of the wealth, income followed by business as the main source of HNWI wealth. Europe Ownership of business, business sales and transfer of wealth between generations Central and Eastern Europe Strong Economic Development Asia- Pacific Strong Economic Development Latin America Strong hold of the traditional offshore banking Middle East Oil Driven growth of wealth management Africa Commodity Driven growth of wealth management 5. Economic Growth as the Main Driver The regional differences of the key drivers of the wealth management points out to the importance of economic growth in determining the wealth management. In most of the regions in the world, it is seen from the table above, economic development is the major factor contributing to the regional differences and the regional specificities associated with the functions. Ups and downs in the markets have been considered as a major challenge that would affect the profitability and growth of the private banking and wealth management sector. While wealth management is basically a service provided across customer categories, the focus is always on the affluence of the customer which is directly related with the economic development of the economies. China is the best example of economic growth driven wealth management. With the unprecedented economic growth in recent years, China now possesses the second largest wealth management in Asia. It is reported that in 2007, the number of High Net Worth Individuals (HNWI) in China reached up almost 8% from 2005 and in terms of HNWI wealth in Asia and Pacific, about one – fifth resides in china. Though the country remains in its infancy, but it is expected to evolve rapidly, in line with the development de-regulation of financial markets. The key to growth is dependent on a number of factors of which economic growth is a major driver. The following table strengthens this view. Table.2 Where Does the HNWI Wealth Come From? Source: Merril Lynch / Cap Gemini World Wealth Report 2006 The wealth of High Net Worth Individuals (HNWI), in most of the regional situations, is constituted mainly by business ownership and the income from different sources. Business ownership, in quantified terms, is directly related with the economic growth of the particular context under discussion and same is the case with income levels as well. These together constitute the major contributors to the HNWI according to the table above. Thus the table brings these two elements in direct relation – that is, economic growth and HNWI and wealth management. Private banking institutions have developed their business models and changed their strategies in such a way that they can take the advantage of the new opportunities given by the economic development and higher growth markets. The newly emerging wealth markets are located in Asia, the Middle East, Latin America and Eastern Europe. The growth of the profit of the wealth managers and private banking is expected to be mid-market the High Net Worth Investors in the developed markets of North America and Europe as well as in the newly emerging wealth markets with strong growth potential. The newly emerged trends of wealth markets and private banking may be reinforcing the link between economic growth and private banking. Given the projected economic growth over the coming decades, private banking firms have focussed their attention on the BRIC economies of Brazil, Russia, India and China. India’s economy is expected to be larger than Japan’s by 2032 while China’s will be larger than the US by 2041 and it will be the second biggest economy in the world by 2016. It is also estimated that the combined BRIC economies will be larger than the present G6 countries of US, Japan, UK, Germany, France and Italy by 2039. Now the global private banking firms are more and actively developing their strategies and activities concentrating China, India and Russia, the fast growing developing countries. New clients and HNWIs will be emerging form these three economies. This will result in creation of their wealth through entrepreneurial activity and they will seek the services of wealth management. They will have to find out the services that reflect their greater familiarity with more complex financing options coupled with relatively strong protection or regulatory factors. The growth of private banking business in North America and Europe comes from the well established clients. The North American wealth market is growing faster than that of Europe and that remains as a key market for wealth management. In emerging markets of Asia, Easterm Europe and Latin America, the demand for wealth management services is mainly coming from the emerging entrepreneurial clients while in the Middle East, it is from the inherited wealth as well as from clients that have businesses related mainly to the energy sectors. Some country examples will clarify the positive correlation between the economic development and private banking. In China, the High Net Worth wealth is roughly calculated as around $0.91 trillion in 2004 and this is estimated to grow to $1.73 trillion by 2009 with an annual growth rate of 14 %. In Russia, it is perceived as the key growth market in Eatern Europe. It is estimated that the HNWI wealth is estimated to amount to around $320 billion and this will be doubled by 2009. At present, most of this is held offshore. In India, HNW wealth is estimated to be $310 billion (this will be similar in size that of Russia. The market is expected to grow by around 10%-15% annually to $520 billion in 2009. In Brazil there is stronger wealth opportunities than the Europe and North America. Growth in the offshore wealth management is expected to lag that of onshore activities. Singapore and Hong Kong seem to be as markets that offer the greatest onshore potential. Offshore wealth will grow slower than onshore wealth, especially in Europe which is driven mainly by regulatory frameworks related to transparency and disclosure of activities. 6. Ranking and Scale of Private Banking on the basis of economic growth By considering assets under wealth management, ratio of clients to relationship managers and services offered and profitability, the Euromoney’s Annual Private Bank and Wealth Management made the ranking of global private banking assets under management. According to this the assets under management have increased by over 128 percent in 2010. According to this poll conducted by Euromoney, JPMorgen got the first rank.JPMorgan is termed as “the best private bank for ultra high net worth ($35m+) in 2010” in the poll results. The largest private banking division is at UBS AG followed by Citigroup and Merrill Lynch as per the survey of Scorpio Partnerships Annual Private Banking Benchmark for 2006. The assets under management gathered by all these three institutions for private clients amounted to more than $1 trillion. Private banking witnessed a tremendous increase in profits and assets under management in 2006 unlike the year of slow growth by 3.8 percent in 2004 (Costa, 2009). The major locations for private banking are Switzerland and Luxembourg and Swiss banks take hold of an estimated 35 percent of global private banking funds with an estimated amount of 4.6 trillion Swiss francs. Traditional private banks like Rothschild and Duncan Lawrie are running on a different business model by not involving in riskier practices and in many cases they are family run businesses and specialize in long term banking and investment practices that have engaged over the centuries. By considering the assets, the five largest private banks in the United States in the year 2008 are as follows: 1. Merrill Lynch ($ 1.05 trillion) 2. Citi Global Wealth Management ($843 billion) 3. Bank of America Global Wealth ($653.2 billion) 4. Wachovia ($ 551 billion) 5. Morgan Stanley Global Wealth Management ($423.0 billion) The global wealth management sector has maintained the pace of prosperity showing an average rate of increase of 14 percent in assets under management in base currency terms as per the findings of the Private Banking Benchmark 2007 from a prominent consultancy of Scorpio Partneship. 7. Economic Development as the Key Driver of Wealth Management- The Case of Asia Asian experience shows the best example for the wealth management inspired and driven by the economic growth. Some unique features are seen in the private banking and wealth management sector in Asia. Compared to Europe and the US, the volume of funds under management (FUM) is smaller, but it has been growing rapidly. High Networth Clients (HNWC) in Asia expanded by 12.5 percent in 2007 as per the survey report ‘Asia Pacific Wealth Report 2008) by Capgemini and Merrill Lynch. 30 percent of the world’s HNWC population is located at Asia and 23 percent of the gloabal HNWC wealth. India, China and South Korea especially experienced the highest HNWC population growth with 22.7 percent, 20.3 percent and 18.9 percent respectively during 2007. This rapid growth rates of FUM in Asia occurred due to the recent origins of economic growth in this part of the world. Asian wealth is emerged during the 1960’s when countries started to shift from the restrictive and regulatory socialist model of development to an economically driven growth path based private ownership and free economy. The nature of economic growth in Asia has been started recently and it is based on the adoption of technology from Japan and the West as well as application of these technologies without wasting time and resources. With this technological innovations, low growth economies with major sector as agriculture are shifting to industrial sector. Many of these countries selected technical education for the investment to make their rapidly growing population equipped with modern technology. These factors contributed the economic growth of Asia and the prospects for economic growth rates in Asia in general continue to be high. It is natural that this rapid economic growth generates income and wealth in private hands. Accordingly, private banking assets have been growing rapidly. It is important to keep in mind that these growth rates are with high savings than in the US and Europe. Savings rates in Asia range between 20 percent to 50 percent accompanied by the new and complicated investment practices. 8. Concluding Remarks The above discussion points out the importance of wealth management and private banking business which is presently a major area for development. It is also to be noted that industry is highly fragmented and there is no any agreed preferred model. The industry is increasingly being viewed as ‘the aggregatore, and the suppliers to the bank (internal and external to the bank) provide a range of services that can be offered individually and if bundled together, to meet the clients. Such an aggregation means that wealth managers are simple and efficient in sourcing, distributing and identifying value enhancing services. All over the world, the level of sophistication and application of more complex services and products are increasing at an increasing rate in the area of private banking and wealth management. As the businesses and the number of wealthy persons grow, the market of wealth management expands and matures and there will be significant changes in the product offering, service levels and channels of offering. References Capgemini and Lynch, Merrill. (2008). Asia Pacific Wealth Report. Hiufen, Chen. (2008). Private Banking Industry Booming, Business Times, Singapore 17, March. Costa, L.(2005). Questions Replace Investment Truths: A Comment, CFA Institute Private Wealth Management, May. Dufey, Gunter. (2009). Private Banking in Asia - A Survey (August 28, 2009). 22nd ustralasian Finance and Banking Conference 2009. Available at SSRN: http://ssrn.com/abstract=1463261 Maude, David (2009). Private Banking and Wealth Management: The New Realities, Wiley Finance, 2006. Nardi, De, Mariacristina. (2005). http:wws.chicagofed.org/publications/workingpapers/wp2005 PricewaterhouseCoopers. (2006). Global Private Banks/Wealth Management. available at www.pwc.com/wealth Scorpio Partnership (2007). Private Banking Benchmark 2007. available at www.scorpiopartnership.com Tijo, Hans (2008). The Regulation of Wealth Management, Published by the Center for Commercial Law Studies, National University of Singapore. Yeh, C (2009). Investors Challeng Market Truths, CFA Institute Private Wealth Management, August. Read More