European private banks are being squeezed by falls in assets and contracting profit margins, with the market expected to remain difficult for such firms in the next three years although prospects are rosier further out, according to a survey of the sector by McKinsey, the management consultancy.

Assets under management at private banks dropped by an average of 15 per cent last year, dragging asset levels down to 2005 levels, according to the report, which echoed other recent reports by PricewaterhouseCoopers and Merrill Lynch/Capgemini in portraying an industry under pressure.

For the full year of 2008, the industry's operating profit pool was 42 per cent below the level of 2007. Profit margins went down from 35 to 26 basis points of assets under management and the cost-income ratio rose from 64 per cent to 71 per cent.

“Looking ahead, long-term fundamentals remain healthy but scenarios for the next three years range from a flat asset base to asset growth of 8 per cent and more, depending on the economic and financial market recovery,” said the report, entitled McKinsey European Private Banking Survey 2009.

The survey is based on data from 103 banks across all different business models and 15 countries. Some 68 of firms surveyed are private banking units of universal banks and 32 per cent are specialist banks. McKinsey analysed financial data from the full year 2008 and qualitative data around organisation, product and service offering, delivery model, risk management procedures, and cost management efforts.

"The long-term prospects for private banking remain healthy," says Frederic Vandenberghe, partner and author of the report.

In relative terms, revenue margins declined from 96 bps in 2007 to 90 bps in 2008. In the fourth quarter of last year, revenue margins were even down to 84 bps. Almost 5 bps of the decline in revenue margins can be attributed to an unfavourable shift in asset allocation to lower-margin, lower-risk asset classes such as fixed income, cash, and savings.

Almost 4 bps of the margin change were linked to the decline in the share of managed assets, both in discretionary and in mutual funds. These revenue reductions had a significant impact on operating profits as private banks have been slow to respond, with only one-third of the banks reducing their cost base in line with the decline in assets.

In general, private banking customers have started to move away from managed assets. The share of discretionary mandates fell from 24 per cent to 22 per cent and the share of mutual funds decreased from 29 per cent to 25 per cent of the assets.

Switzerland maintained net inflows of 2 per cent in 2008, although net inflows decreased from 7 per cent in 2007. Due to their global reach, Swiss private banks attracted 65 per cent of net inflows from outside western Europe. They were also able to keep their high revenue margins (96 bp in 2008).

In Germany, Europe's largest onshore market, private banking saw a decrease in net inflows from 9 per cent in 2007 to 2 per cent in 2008 and deteriorating profit margins (down one-third from 30 bps to 19 bps).

While offshore has constantly been lagging behind onshore growth, net inflows were still positive. In 2008, offshore net inflows were 2 per cent compared with onshore net inflows of 3 per cent, the survey added.