The wealth management industry is operating at its lowest recorded profit margin levels, and while assets under management rose last year, client inflows accounted for a small fraction of the increase, according to a report highlighting business strains from consultants McKinsey.

Among the key findings of the report, based on data from 160 banks, was that onshore universal banks had the strongest momentum, but other firms were catching up to occupy the best positions in a more consolidated market.

The profit margin figure for 2009 was one of the most striking aspects of the report, echoing a recent similar comment on the issue from Scorpio Partnership. (To view that article, click here). Profit margins went down to 20 basis points of assets under management in 2009 from a previous figure of 26 and the cost-income ratio rose to 76 per cent from 71 per cent in 2008. Industry-wide operating profits declined 25 per cent and reached half of the pre-crisis level of 2007.

“The massive hit to private banking economics has forced banks to start overhauling business models, using the financial crisis as a catalyst to reshape one of the most attractive segments in the financial services industry,” said the McKinsey European Private Banking Survey 2010.

The survey analyzed 100 banks in 18 west European countries: 75 per cent of them were private banking units of universal banks, while 25 per cent of the remaining institutions were specialist banks. McKinsey analyzed financial data from the full year 2009 and qualitative data relating to organization, product and service offering, delivery model, risk management procedures, and cost management efforts.

"Profit levels hit a low in 2009. Increasing competition for deposits as well as very low portfolio activity have been the main reasons for this. AuM growth was almost fully driven by investment performance, while net inflows of about 1 per cent reached a low," says Frederic Vandenberghe, director and author of McKinsey's European Private Banking Survey.

 "Onshore markets continue to be very attractive with growth expectations above GDP growth, while offshore markets will continue to develop from a more tax-driven proposition to newviable business models."

AuM increased 10 per cent on average, gradually recovering from the asset erosion of -15 per cent in 2008. This increase was mainly driven by the rebound in investment performance due to favourable global equity markets, which induced an average investment performance of 9 per cent.

The net inflow contribution of 1 per cent remained below levels of 2004-2008 (between 3 per cent and 8 per cent), suggesting a relative lack of wealth creation, the report said.

A lack of wealth creation in the economy as well as investor interest in real estate and other tangible assets such as gold were among the main reasons for the low inflows of 2009, the report showed.

Different regional markets and private banking business models experienced strong differences in inflows. Onshore market net inflow averaged +3 per cent while offshore markets suffered a net outflow of -2 per cent. Within onshore markets, universal banks averaged +4% net inflows in their home markets, half of the growth being brought through internal client referrals. Independent boutiques averaged +3 per cent inflows while booking centres of international private banks suffered significantly with a -3 per cent outflow.

European banking models suffered polarised performance. For example, Switzerland experienced outflows of 1 per cent in 2009 despite an overall 11 per cent growth of AuM, although stable inflows from all global regions except Western Europe and the US reconfirmed the strong global positioning of Swiss wealth management. The revenue and profit margins of Swiss private banks decreased while the cost margin remained steady. Luxembourg experienced significant outflows of 5 per cent in 2009 because of its focus on Western European money.

 Despite this, private banks in Luxembourg continue to be Europe's champion in terms of profitability with a profit margin of 42 bps in 2009, more than twice the European average. Net inflows in Germany fell from 2 per cent in 2008 to 0.5 per cent in 2009. Profit margins deteriorated more than 30 per cent from 19 bps to 12 bps. Net inflows in Italy fell to 2 per cent in 2009 (4 per cent in 2008 and 8 per cent in 2007) and Italian private banks experienced a significant drop in revenues to 55 bps in 2009 (68 bps in 2008).

Again, reflecting other reports, McKinsey said that overall customer satisfaction and loyalty have declined in the crisis. Considerable variations in net inflows between individual banks (€17 million (around $22.1 million) net inflows per relationship manager for top banks vs €8 million net outflows per relationship manager for banks at the bottom of the table), in an environment of close to zero overall net inflows, indicate that many customers have changed their bank or plan to do so.

New regulation and government initiatives in Europe and the US have put offshore private banking under pressure leading to outflows of -2 per cent whereas onshore booking centres saw 3 per cent inflows.