Financial Institution Review
By MBMG IA
As part of our role for our clients MBMG IA continually assesses the risks to which clients are exposed.
These include the risks of service providers
In light of recent events, having this monitoring available has proven extremely useful.
We usually share this information when we are conducting reviews or comparisons for clients or if changes in our data give rise to concerns. Following recent events which have seen 3 bank failures in a short period of time in USA, we have compiled an update for each client of their bank provider risk.
We have divided this into 4 parts – global private banks, regional private banks, Thai banks and other counterparties.
While the specific information for each client is of course both bespoke and confidential, we have decided to share the generic components of each of these four reports, in case this is of broader interest.
MBMG IA Financial Institution Review
Part One Global Private Banks
Barron’s Dictionary of Banking Terms defines private banking as banking services, including lending and investment management, for wealthy individuals. Private banking primarily is a credit service, and is less dependent on accepting deposits than retail banking.
Another interpretation can be found in Federal Reserve Supervisory Letter (SR97-19), which defines private banking as the provision of personalized services including money management, financial advice, and investment services for high-net-worth clients.
Private banking risks
In theory, Private Banking should, in many respects, represent a lower risk model than commercial banking. For instance, it has been purported that private banking carries much lower credit risk.
“Credit risk is usually a minor risk factor for private banking firms. The extensions of credit to high-net-worth individuals by most private bankers is incidental to procuring the clients more lucrative investment management business. However, credit risk is often minimized, since the majority of private banking lending is often fully secured either by cash or securities.” [1]
Credit risk (typically loans defaulting resulting in losses for the lender) were at the heart of the Global Financial Crisis of 2007-9. During this time many banks operating in the private banking space did encounter difficulties (notably Credit Suisse and UBS) although this was largely due to their investment banking and commercial banking losses and exposures. Although many organisations subsequently decided to step away from these riskier activities, there remain many institutions whose models are sufficiently hybrid (i.e. a combination of private banking and riskier activities) that we strongly recommend that any analysis of private bank risk takes into account whether or not they, or their affiliates, engage in riskier activities or not. Notably many jurisdictions now prevent private banks from undertaking commercial banking activities, although this varies according to location. The fact that institutions may at some level engage in or be related to affiliates who engage in activities which at some level involve riskier activities doesn’t necessarily mean that they should be ruled out – in fact very few pure play private banks operate at significant global scale as can be seen from the table below where only one of the top 10 global private banks operates primarily as a private bank.
Top 10 global private bank brands –
This doesn’t automatically disqualify banks with hybrid risk structures from consideration but it does mean that the risks to private bank clients - which vary according to the nature and scale of the riskier activities and the structure of the entity – need to be fully understood. However, making such assessments can be complex and challenging and this can give an advantage to institutions primarily focused on private banking. In addition to LGT Bank, there are other, mainly European, primarily Swiss institutions, such as Lombard Odier, Bank Pictet and Bank Vontobel among others, in addition to regional or catonal banks, whose models are essentially built on a less complex, primarily private banking model may merit consideration.
Pas a result of this limited credit risk, pure play private banks generally emerged unscathed from the global financial crisis.
Historically, the main risk facing private banks has been operational risk.
While operational risk can take many forms, it essentially boils down to private banks making mistakes or errors (e.g. in executing transactions or communicating information to clients) for which the bank bears responsibility and is on the hook for resulting losses. For well-run organisations, this is not typically an existential threat and it is hard to recall the failure of a pure play private bank because of operational risks, although these should be considered in tandem with regulatory risks.
Regulatory risks can encompass 2 major aspects – one is where banks are forced to compensate a client, or more typically a broader group of clients because the bank has been deemed by regulatory or enforcement authorities to have caused losses to clients, which the bank is forced to make good. The second aspect is the impositions of fines or penalties by regulatory bodies.
The table below shows the ten most fined banks of the last 10 years:
(Based on data compiled by Forex Suggest)
While few major banks have failed due to sanctions imposed, it is part of the overall picture of bank safety.
We mentioned above that restrictions on banking model activities vary from jurisdiction to jurisdiction, but in fact so do most if not all banking regulations. American banks generally have lower capital and liquidity ratio requirements than European banks and therefore should be considered as being at greater jurisdictional risk because of less stringent regulation. European private banks generally exhibit higher degrees of capital adequacy as shown in the following table where the major US banks fall below the European minimum requirement of 13% (data as of June 2022 or latest then available - the higher the number the safer the bank from a Tier 1 Capital perspective):
Of course Tier 1 capital ratios are simply a snapshot of a moment in time – the performance of the institution needs to be monitored – for instance in the case of Credit Suisse, we had been expressing concerns about the risks involved in their businesses and products for many years, which we escalated in 2018 and then last year began to warn that the bank’s ongoing position may no longer be viable, and in the case of Deutsche Bank, we have been notably scathing about the risks of their model for almost a decade now. (https://www.cnbc.com/2016/09/30/the-man-who-called-deutsches-decline-has-some-gloomy-predictions-on-whatll-happen-next.html )
Tier 1 capital is also only one measure- additional measures such as Tier 1 leverage ratio are important – Tier 1 leverage ratio looks at capital in relation to business loan activity or volume – again, the higher ratio, the safer (if taken in conjunction with the Tier 1 ratio itself)
There are also many other aspects to jurisdictional risk that need to be taken into account. One key aspect is asset custody – in many jurisdictions assets have to be held in 3rd party custody – in such an event the assets themselves may not be affected by the failure of the private bank (although in many cases deposits and even assets relying on the credit of the private bank may be at risk – this highlights the need to conduct due diligence also at a product level – for instance it’s possible to hold your assets at a high quality private bank but if you invest in, for instance structured products underwritten by another private bank, those products may be impaired by the failure of that other bank as many Singapore private bank clients discovered when Lehman Brothers failed during the GFC – this is yet another reason to be wary of structured products). Nothing highlights the stark differences between jurisdictions, such as the higher capital requirements of post-Basel European banks compared to the more lenient standards applied to American banks than the fact that the strongest 2 banks in America last year, according to the stress tests conducted by the Federal Reserve, were Deutsche Bank and Credit Suisse!
Many factors indicate the health of a financial institution but in private banking the risk inherent in the model, the capital adequacy, the extent of leverage, the quality of assets and the regulatory, jurisdictional and operational risk factors all help to inform.
This general report is for information only and is in no way a substitute for a detailed assessment and analysis of a specific institution or comparison between institutions. No decisions should be taken purely in response to reading this general content and neither MBMG IA nor its officers can accept any liability or responsibility for any actions taken or not taken as a result of reading this report.
This report also relies on information compiled from various sources, believed to be reliable but for which no accuracy is claimed or to be relied upon. However, as always a list of sources is available upon request.
It is intended to distribute the remaining general Parts of this report in due course.
[1] QUESTIONS EVERY BANKER WOULD LIKE TO ASK ABOUT PRIVATE BANKING AND THEIR ANSWERS - Michael Atz, Emerging Issues Series Supervision and Regulation Department Federal Reserve Bank of Chicago