Large Swiss private banks have significant competitive advantages thanks to economies of scale. At the other end of the spectrum, things are more difficult.
After the Corona crash in early 2020, Swiss private banks benefited from the favorable market environment the following year, as the results of PWC Switzerland's «Private Banking Switzerland: Market Update 2022» showed.
The strong performance of the financial markets in 2021 led to record results, especially for large and medium-sized private banks, while smaller competitors were able to postpone a thorough review of their difficult profitability situation.
Attractive Financial Center
Large private banks saw net new money (NNM) inflows up 4.4 percent in 2021, according to the study, with assets under management (AuM) averaging 290 billion Swiss francs ($317 billion) per institution at the end of 2021. At mid-sized institutions, assets under management increased 14 percent to an average of 15 billion francs per bank. Smaller institutions increased net new money inflows to an average of 4.3 percent.
These results underline the attractiveness of Swiss private banks as trustworthy financial partners, they say. Thanks to their good reputation, the study authors expect the banks' net new money inflows to remain constant at around 4 percent in the future, regardless of market conditions. However, small and medium-sized banks will have greater difficulty in attracting new money, especially as they are more dependent on a favorable market environment than their larger competitors.
Competitive Pressure
Operating income relative to assets under management turned a corner in 2021 after the firms had been under pressure since 2017. Large banks stabilized their income margin at around 61 basis points. Combined with increased AuM, this resulted in record high income in absolute terms. Medium-sized private banks achieved a result of 76 basis points. Small institutions recorded the largest income margin of 98 basis points due to their large share of private clients. Still, in absolute terms, they were unable to generate significant profits.
According to PWC, competitive pressure will not ease in the coming periods and will hurt net fee and commission margins. However, as a result of the rise in general interest rates, net interest income is expected to increase in the coming years, which will have a positive impact on the margin of the overall operating result.
Efficiency Gains
The large and medium-sized private banks operated most efficiently, and despite an increase in absolute costs, they were able to convert the majority of the increased AuM volume into profits. This resulted in a significantly improved average cost-income ratio (CIR) of 66 percent for large banks and 77 percent for medium-sized institutions - the lowest CIR since 2017. Smaller providers, on the other hand, could not keep pace as their baseline costs largely offset the income generated, achieving a CIR of 92 percent.
(Source: PWC)
The gap between small and large banks will continue to widen, according to PWC. Large banks will continue to benefit from economies of scale and achieve a CIR of around 65 to 70 percent in a favorable market environment, while smaller private banks, on the other hand, will continue to struggle to improve their operating profitability. The CIR for those institutions will remain high, averaging over 90 percent according to the report.
Challenges For Smaller Firms
Large private banks also performed significantly better than small and medium-sized institutions in terms of operating return on equity during the period under review. This trend has intensified in the last two years and shows that economies of scale in the private banking sector that were important before, will become even more so.
Thanks to that dynamic, large private banks are expected to achieve even better operating returns on equity during favorable market environments, generating significant shareholder value. The smaller ones will struggle to increase their operating profits and create value for their investors.
Mergers and Acquisitions
Although 2021 can be considered an extremely good year for private banks in many aspected, it is no guarantee of future returns as the familiar disclaimer goes. PWC expects M&A activity to increase as the market environment deteriorates, having a particular impact on the smaller private banks, where further consolidation trends are to be expected.
PWC said 68 private banks were involved in the study, covering 72 percent of the market, and included those that provided consistent data for the observation period of the study which was five years. The banks were classified by AuM as small (<5 bn CHF), medium (5 to 50 bn CHF), and large (>50 bn).
Outlook
Because private banks have built their brands and trustworthiness over decades and in some cases generations, PWC said that generally expect banks to achieve constant NNM growth rates of around 4% annually irrespective of the general market environment.
Not only does size matter when it comes to economies of scale and other dynamics, but the same is also true for the jobs. PWC assumes large banks will further expand their full-time employee ranks in the next few years, while the number of employees at small banks will stay more or less flat. Additionally, a slight increase in the annual expenses per headcount at all banking groups due to high competition in finding qualified employees is to be expected, PWC says.
