A shift to 65%?
An overly-simple rationale for this difference is either that investment decisions and processes have greater complexity and cost than credit-risk assessments and lending processes, or that end customers are more willing to pay for being lent money, than they are for services and advice to invest money.
Without getting into a philosophical and potentially ethical debate about whether, and why, consumers do pay more for debt than investments, let’s focus on the more tangible discussion of reducing complexity and costs in wealth and asset management.
Is a CIR of 75% really so bad?
Many COOs of private banks would not view a CIR of 75% as problematic in itself. It is after all an industry average – one of many benchmarks to consider. As long as the firm is not operating too far above it for too long, it is quite manageable. As the head of a large private banking group recently suggested, if the firm is growing and undertaking significant investments to support that growth, then running above 75% is quite acceptable.
Nevertheless, with the massive investments in digitalization & AI over recent years, many in the industry are questioning whether they can reduce operational costs further, and adjust the operational mix to achieve a lower ratio. With competition getting fiercer, and investors becoming ever more aware and sensitive to high fees and charges, this question is becoming increasingly pertinent.
Before considering what could reduce the ratio, it is worth pointing out that some private banks do operate already in the 65% CIR range. However, for the most part this is because their particular business model is focused on lending and financing for wealthy individuals and their businesses, rather than advice and asset management. When looking at firms where the majority of revenue comes from advisory and asset servicing fees, their CIRs are typically higher.
So how could private banks adjust the cost model to get closer to 65%? Let’s looks at some key cost factors:
1. Relationship management and advisor staff costs.
The majority of operational expenses in private banking relate to front-office staff salaries. While digitisation will chisel away at the number of advisors and support staff needed per investor, we can assume that they will continue to command high salaries – and cutting staff who are managing client service and relationship is a highly risky option.
2. Staff costs for specialist, non-standardizable products and services.
This category includes, for example, security structuring, private markets, tax and trust services. Functions which require highly expert staff. While these represent a smaller chunk of the total cost, as they are smaller teams, they are frequently critical to some of the most lucrative elements of private banking - this is not easy fix either.
3. Customised portfolios and fee-models.
While custom service is considered core, many private banks have expanded rapidly and advisor teams now have to deal with large amounts of legacy custom portfolios and complexity. Frequently, when considering the amount invested, specific investor requirements or risk-profiles, or the relative performance, many client portfolios do not warrant such high levels of customisation. There is an opportunity here to move many clients to more standardised model portfolios and simpler fee structures.
4. Third-party fund distribution costs.
The fund industry is clearly transforming as large swathes of investors shift towards simple core-satellite, ETF-based investment strategies with expense ratios south of 100bps. Private banks may have to forgo some chunky retrocession fees, but a simplified model for bulk public market investments could be an answer to reducing the cost basis significantly. This is especially so if the bank can get clients to shift portfolios to standardized, centrally-managed, discretionary mandates, which at the same time, bolster recurring fee revenues.
5. Client admin and business operations costs.
Admin and operations staff are amongst the lowest salaried staff in a bank, but can still represent 30-40% of the cost. With constant rounds of outsourcing and tech investment, the expectation is that costs will get much lower. Frequently, however, there remains a significant amount of legacy technology in place to manage, and many gaps in process flows. Why is it, for example, that after multiple decades of portfolio management and risk analytics the technology is still so costly to operate? Why is that that client admin staff and risk officers are still underwater dealing with onboarding, KYC compliance and regulatory processes?
It is not easy for private bank COOs to achieve lower CIR levels, especially if they want to focus on growing wealth advisory and asset allocation services. However, there is potential to change the ratio by adjusting the cost-mix of the bank. Investing in technology, such as digitalisation and AI, and switching to standardised model portfolios and ETFs for the bulk-bracket public markets provides the most promising route for getting to 65%.
*Image: MS Dall.e