Private banking remains one of the most attractive businesses in the banking sector, with pre-tax profit margins of 35 per cent and 14 per cent revenue growth, according to the recently released McKinsey 2007 European Private Banking Survey.

Private banking remains one of the most attractive businesses in the banking sector, with pre-tax profit margins of 35 per cent and 14 per cent revenue growth, according to the recently released McKinsey 2007 European Private Banking Survey.

The report also offers private banks a number of strategic suggestions for the future, most importantly to focus on the ultra-high net worth segment.

The management consultants say that while the European profit pool has more than doubled since 2002, the market still shows significant potential for growth and is expected to structurally grow above GDP.

The survey, based upon data from 105 European private banks across different business models and countries, claims that nearly half the onshore assets of high net worth individuals are still not managed by private banking channels.

In 2006, assets managed by private banks in Europe grew by 14 per cent, according to McKinsey.

Investment performance of 6 per cent was 3 per cent lower than in 2005, but net new money inflows grew from 7 per cent in 2005 to 8 per cent in 2006.

And the difference between winners and losers is increasing. Top-quartile players grew by 31 per cent, over 10 times faster than bottom-quartile players, clearly indicating a rising bar for capturing the full growth potential of the sector.

The main growth is increasingly coming from the more sophisticated segments and products – ultra high net worth investors (who are defined by the survey as having more than €30 million in liquid assets in one bank) and alternative investment products, such as commodities, hedge funds, structured products, and real estate.

UHNW clients represented 26 per cent of private banks' asset base in 2006, up from 23 per cent in 2005, showing a growth rate about twice as fast as other segments. The growth difference between structured/alternatives and all other products was found to be 27 per cent.

A similar growth gap could be found if one compared the fastest-growing offshore markets (Asia, Middle East, Eastern Europe) to other geographic markets.

Banks with greater exposure to the UHNW client segment, such as investment banks amongst others, have been the biggest beneficiaries of this growth.

Frederic Vandenberghe, partner and leader of McKinsey's European Private Banking Practice, said: "In 2006, the private banking industry demonstrated another year of impressive growth in assets and profits, and the industry's long-term fundamentals still look very good. Yet, given the increasing complexity and sophistication of clients and offerings, and the further professionalisation of selected players, the bar to be amongst the winners continues to rise. The winning banks will be those that are able to innovate and tailor client service and products, invest effectively and consistently in growth and talent, deliver quality advice in a more complex investment universe, and tap into new growth markets."

The survey, the sixth that McKinsey has produced on the European wealth management sector, also offers advice on which strategies to adopt in what it sees as a more competitive future environment.

Private banks should adapt service to the needs of each segment, especially for ultra high net worth clients. Although these clients are inherently tougher to serve, as they often require multiple booking centres around the world, a seamless integration of asset management and investment banking products, and very senior/specialized relationship managers, banks clearly "betting" on this segment outgrow their peers, says McKinsey.

They should also deliver value-added to clients. The survey suggests that professional investment management is (or at least, should be) a cornerstone of any private bank's proposition. But differences in investment performance between various private banks are quite considerable. Average performance of a bank's equity model portfolio can differ by more than 5 per cent between top- and bottom-quartile players. Regulations will force more transparency of pricing and investment performance, so the true value-added of the private bank, its relationship managers, and its portfolio managers may require further professionalism for some.

Private banks should invest consistently for growth but this comes at a price. The survey results show that players that grew their cost base most radically (by 27 per cent) also expanded their base of relationship managers (18 per cent) and their assets under management increased above the average (24 versus 14 per cent).

Worst off were those banks just "going with the flow" and keeping their costs flat. They, on average, lost 9 per cent of their relationship managers and grew their assets under management by only 4 per cent, less than the average market performance.

The consistency of investment into growth will be even more critical during the next downturn. McKinsey experts argue that "private banks that just try to rise with the tide, not having a clear growth strategy, are doomed. Not investing is largely equivalent to slowly running off the franchise. Exiting at current valuation multiples is likely to be more attractive for them."

McKinsey further argues that private banks should develop a differentiated talent proposition. With payouts to relationship managers typically ranging from 7 to 15 per cent of client revenue and cost income ratios of approximately 65 per cent, there is ample space for relationship manager poaching through increasing salaries. But, payout is not everything: banks will need to evolve the way in which they develop and evaluate talent. The consultants belief is that the "end game" on talent is likely to be closer to professional service firms than to traditional retail or brokerage environments.

And private banks should truly broaden the investment product range. Four product categories grew by more than 30 per cent in the average portfolio of HNWs in 2006: commodities, hedge funds, structured products, and real estate. These products generate more than 15 per cent of revenue, says McKinsey.

Finally, McKinsey says that private banks should focus on growth markets. While HNW investors from "old Europe" still hold more than half the stock of offshore money in countries such as Switzerland, some players get more than two-thirds of their net new money from the emerging growth markets of Eastern Europe, the Middle East, and Latin America.

However, timing of entry into a new market remains of critical importance for onshore markets. With a growth rate of 23 per cent, Iberia grew more rapidly than all other European markets in 2006. After several years of impressive above average growth, private banks in Belgium grew at 18 per cent, which is closer to the European average.

McKinsey cautions that there is no single client profile: young and old, affluent and very rich. Slightly more than half of all private banking clients are over 60 years old, but another one-third is in the 40- to 60-year age group – and the rest are even younger.

While the clients with assets of more than €10 million in any single bank are small in number, their aggregate assets represent 40 per cent of the total asset base of private banks. In comparison, the merely affluent clients with less than €1 million still represent 24 per cent of the asset base.

Not surprisingly, the survey reports that the very rich invest differently. They prefer higher-risk products although they still have a substantial need for advice – nearly 40 per cent still delegate the investment decision to the private bank or pay a fee for an advisory mandate, which is nearly as much as that observed for the remaining HNW investors.