Future-oriented private banks face a time crunch to reorganise before the end of a temporary “inversion” in what generates their income. Private banks, historically able to rely very heavily on their hefty fees and commissions, have seen interest profits soar. According to a new Deloitte/FNZ white paper, private banks will have to get serious about outsourcing if they want to prosper once they come down.
Historically, according to the report, a private bank got around 65 percent of its income from advisory and asset management services. By contrast, it got about 20 percent from interest on client lending activity.
“In the past two years, it has inverted,” said Pascal Martino, a Deloitte partner who serves as the firm’s banking leader and human capital advisory leader. “It is a fact that this year, banks will benefit a lot from the high interest rates.”
Platform applications
Martino is one of several Deloitte partners who worked with FNZ, which calls itself a “global, end-to-end wealth management platform”, on the white paper, entitled “Achieving tech leadership in private banking,” It looks at how banks can use platform outsourcing to meet changing market demand for digital wealth services and keep up with investor expectations.
“Everyone realises that private banks and banks in general have to transform to become more digital, more agile, provide more services and try to invest for the future when they have uncertainty on revenues, ever-rising costs,” said Martino. “Looking at the revenue, obviously, banks are under pressure,” he added. “And private banks as well.”
“The question,” he added, “is how and do we believe that we can come back to the level we had before. That’s one of the challenges of the industry when the interest rate will go lower again.”
Trouble not new
Trouble in the balance sheets of private banks and even regular banks is not new. A CSSF report from early last year noted that total interest income had already surged 39 percent due to higher central bank interest rates. However, even with this wind in their sails, 23 banks in the Grand Duchy were at that time not profitable, the same as it reported in 2021.
While the Luxembourg financial regulator didn’t name banks, its spokesman pointed to errors banks had made. “Like any other business, some banks may have taken bad strategic decisions in terms of their business development,” said a CSSF spokesman at the time. “Why is it worrisome? In a nutshell, because banks that are not profitable will be less shock-resistant and/or less capable of supporting their private or business customers (i.e. make loans).”
An ABBL press conference in 2022 explained that since 2015, Luxembourg has lost almost a third of its private banks. The banking association noted that private banks in Luxembourg, especially the smaller ones, are struggling as their margins are squeezed by rising costs due to compliance, innovation, sustainability and growing overhead costs.
Old school stubbornness
There is an “old school” way of doing private banking in a European financial centre like Luxembourg that is resistant to change. According to the report “historically, European private banks have favored an in-house approach to their IT and operations, often motivated by the imperatives of banking secrecy and client confidentiality.”
“You can try to be against the iPhone, but everyone has one,” said Martino, who added, “it’s not a question of ‘if’, it’s a question of ‘when’ the private banks will go there … there is no point in fighting against where the world is going.”
Banks have previously tried the outsourcing route to manage their high fixed-cost components, notes the Deloitte report. However, “traditional outsourcing approaches available to banks have often failed to meet expectations,” it states.
Keep control
Private banks have previously tried various kinds of outsourcing. This included partnering with larger banks as well as partial or functional outsourcing such as application service providers, managed services, information technology outsourcing, business process services and application managed services.
Much of this has been driven by a desire to keep control over the banks’ IT systems in-house.
“Trying to develop inside a bank, which is not normally full of IT developers, something which is better than some people focusing on the platform makes no sense at all,” said Martino.
Varying your costs
The report advocates “more comprehensive end-to-end platform operating models”, identifying it as “capable of providing a digital technology advantage by enhancing time-to-market, reducing cost-to-serve and introducing variability into the operational cost structure.”
With the platform-based solution, said Martino, “you ‘variabilise’ your costs on one side, on the other side, you’re also more easily able to activate new markets, new segments, new products, new services, to reactivate this part of commission-based fees.”