Private Banking Chapter

Chapter 7
Private Banking
The Presentation Slides for Teaching
Financial Regulations and Compliance Practices
Website : https://sites.google.com/site/quanrisk
E-mail : quanrisk@gmail.com
Copyright © 2016 CapitaLogic Limited

Declaration
Copyright © 2016 CapitaLogic Limited.
All rights reserved. No part of this presentation file may be
reproduced, in any form or by any means, without written
permission from CapitaLogic Limited.
Authored by Dr. LAM Yat-fai (林日辉林日辉林日辉林日辉),
Principal, Structured Products Analytics, CapitaLogic Limited,
Adjunct Professor of Finance, City University of Hong Kong,
Doctor of Business Administration (Finance),
CFA, CAIA, CAMS, FRM, PRM.
Copyright © 2016 CapitaLogic Limited 2

Outline
What is private banking?
Private banking services
Selling of investment products

Private banking
Regulatory definition
Maintain personalized relationship
Receive personalized banking services
Minimum USD 1 mn liquid assets under the
bank’s management or
Minimum USD 3 mn liquid assets
Operational definition
A bank officer visits a customer’s office to conduct
banking transactions for the customer

Wealth pyramid
Private banking
Wealth management

Wealth segmentation of
private banking customers

Source of wealth

Why private banking?
– customer’s perspective
HNWIs have too much money
Safety custodian of wealth
Protection against inflation
Capital appreciation
Tax avoidance and/or deferral
Estate planning
Social status

– bank’s perspective

– bank’s perspective
Good profit = Higher income - Lower cost
Low regulatory capital requirements
Business referral from PB customers
Corporate decision makers
Other high net worth individuals

Incomes
Product service charges
Commissions (from investment banks)
Management fee
Custodian fee
Loan interests
Other service charges

Regulatory capital
Funding from a bank’s shareholders
Operational risk capital charge
1.2% of transaction amount
Credit risk capital charge
0% for lending with full collateral
8% for lending without collateral

Business referrals from
private banking customers

Relationship manager
“ ”Copyright © 2016 CapitaLogic Limited 14

No. of customers serviced by one
relationship manager

Relationship years

Outline

Major private banks in Hong Kong
The Hong Kong and Shanghai Banking
Corporation Limited
Hang Seng Bank Limited
Standard Chartered Bank (Hong Kong) Limited
Bank of China (Hong Kong) Limited
BoC International Limited
Goldman Sachs (Asia) L.L.C.
Morgan Stanley Asia International Limited
JP Morgan Chase Bank, National Association

Major private banks in Hong Kong
UBS AG
Credit Suisse AG
The Bank of East Asia, Limited
BNP Paribas Wealth Management
DBS Bank (Hong Kong) Limited
Deutsche Bank AG
Industrial and Commercial Bank of China (Asia)
Limited
Nomura International (Hong Kong) Limited

Investment classes

Alternative investments
Real estates
Commercial real estates
Private equities
Initial private offer
Commodities
Red wine
Distressed debts
Cyprus sovereign debts
Hedge funds
Quantum fund

HKD 700,000

Collateralized lending
0
1
2
3
4
5
6
7
8
9
10
Collateral Lending
7 7
3

First collateral
1,000,000
HSBC shares

Frist collateral + first loan
1,000,000
700,000
HSBC shares
Loan

First collateral + first investment
1,000,000
700,000
HSBC shares
Tenscent shares

First collateral + first investment
+ second loan
1,000,000
700,000
490,000
HSBC shares
Tenscent shares
Loan

Leverage effect
2 3
1,000,000 + 1,000,000 × 0.7
+ 1,000,000 × 0.7 + 1,000,000 × 0.7 +
1,000,000
=
1 - 0.7
= 3,333,333
⋅⋅⋅

Professional investor
An individual with a portfolio of at least USD 1 mn
A corporation with a sole business to hold investments
and is wholly owned by an individual who has a portfolio
of at least USD 1 mn
A trust with total assets of at least USD 1 mn
A corporation or partnership with either a portfolio of at
least USD 1 mn or total assets of at least USD 5 mn
A professional investor is
not protected by the SFO
protected by contract law

Outline

Regulatory challenges
to private banking

What is this investment product?
Excellent investment product
High return
Low risk
Huge growth potential
Very stable income
As reliable as deposits

Very popular investment product
Mr. FONG acquired HKD 100,000 yesterday
Mr. LEE further brought HKD 500,000 this
morning
Limited offer to very few VIPs like you
Subscription to be closed by this end of today

Today the market is going up
The price will be more expensive tomorrow

Today the market is going down
The price is very attractive today

Sure win selling strategy
HKD 100 ParknShop gift coupon for every
HKD 100,000 subscription

Very familiar conversions

Whom are you talking with?

Regulatory requirements
An financial institution is subject to RA8 asset
management when selling investment products
A financial institution is fully responsible for
mis-selling of investment products
A financial institution is required to implement
a compliance programme to prevent mis-
selling of investment products

Regulatory requirements
Product due diligence
Customer risk profiling
Suitability assessment
On-going monitoring
Crisis management

Product due diligence
Product risk rating: a number from low to
high, classifying the consolidated risk of an
investment product, e.g.
1 – Conservative
2 – Balanced
3 – Moderate
4 – Growth
5 – Aggressive

Risk rating of common products
Product Level
Deposits 1
Government bonds 1 to 2
Corporate bonds 2 to 3
Currency linked deposits 2 to 3
Equity linked notes 4 to 5
Credit linked notes 5

Product rating of RMB bonds

Regulatory product risk factors
SFC’s key facts statement
http://www.sfc.hk/web/EN/regulatory-
functions/products/product-authorization/products-
key-facts-statements.html
HKMA’s important facts statement
http://www.hkma.gov.hk/media/eng/doc/key-
information/guidelines-and-
circular/2011/20110418e1.pdf

Product risk assessment
Qualitative
Expert judgment
Subjective
Time consuming
Less consistent
Very flexible
Quantitative
Model based
Objective
Automated
Consistent
Less flexible

Quantitative product
risk assessment (1)
Market risk
Currency rate, interest rate, equity price and/or commodity price
Volatility
Credit risk
Credit rating of issuer and/or custodian
Operational and legal risks
Complexity of product structures
No derivatives
Derivatives are used for hedging only
Derivatives are used for profit making
Liquidity risk
A lot of investment products, once invested, must be held until
maturity

Quantitative product
risk assessment (2)
Reputation risk
Strategic risk
Using minimum rating
Qualitative factors
Industry consents
Regulatory expectations

Minimum risk level
Money market fund 1
Fixed income fund 2
Balanced fund 3
Equity fund 4
Hedge fund 5

Calibration products
1 – US treasury fund
2 – Fixed income fund
3 – Half fixed income fund + Half equity fund
4 – Blue chip equity fund
5 – Statistically sufficiently above “4”

Peer comparison
HSBC
Hang Seng Bank
DBS(HK)
Wing Lung Bank
Wing Hang Bank
Bank of
Communications
ICBC(Asia)
ANZI(HK)

Point-in-time vs through-the-cycle

Customer risk profiling
A questionnaire with 6 to 12 questions to
assess risk tolerance level of a customer, e.g.
1 – Conservative
2 – Balanced
3 – Moderate
4 – Growth
5 – Aggressive

Tolerance level factors
Income +
Employment +
Assets +
Liabilities -
Investment experience +
No. of dependents -
Education ?
Age ?

Suitablity
assessment
Product
Product risk
level
Product
features
Customer
Risk tolerance
level
Know your
customer

Product risk rating vs risk tolerance level
Product features vs customer characteristics
Investment horizon
Investment objective
Specific product knowledge
Specific market experience
Concentration of exposures

On-going monitoring
Product based monitoring
Typically over 1,000 products
Very difficult and time consuming
Market based monitoring
Major currency rates
Major interest rates
Major equity indices
Major volatility indices
Major credit indices
Credit rating of 10 largest counterparties

Crisis management
Crisis management committee
Working group meeting
Action plan
Close monitoring
Keep on close monitoring
Further close monitoring
Suspend selling risky products
Inform customers who have acquired risky products

Reference
HKSI, 2016. CPWP M2 – Ethics and
Compliance Study Guide.

Private Banking Chapter

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