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Rebuilding UAE private banking franchises

Indeed, the significant legacy of the terrorist attacks in New York was that the Middle East has come under a microscope by the US Treasury and the G-7 central banks as a region where money laundering, terrorist financing and dirty money flows are a national security threat to the West.

This imposes far greater standards of regulatory compliance on private banks, brokers and even hedge funds doing business in the Middle East. The Patriot Act in the United States even forces scrutiny of the clientele of correspondent accounts of regional banks and securities firms.

These are the grim new realities of private banking in the UAE: fear and loathing of the stock market by clients, devastated managed portfolios, virtual breakdown of traditional private banking "secrecy" protocols after 9/11, no rational prospect for strategic growth as Arab money repatriates from offshore locales, cutthroat competition, mass layoffs, shrinking profits margins.

It is no coincidence that a number of major international private banks closed down their Gulf offices in recent years. Bank of America, Barclays, Prudential Securities, Citibank UAE's equities investment business in Dubai are all history. For new private banks that open a new office in the Gulf, the economics of profitability are almost impossible. For instance, high fixed operating costs mean that a satellite office in the AGCC needs to generate at least $80 - 100 million in client assets per annum just to recoup start up costs. This is difficult enough in the best of times. In a bear market the new kid on the block has no rational hope of success.

A decade ago, a global brand was all it took for a private banker to persuade UAE investors to open an investment account. Now, the most discredited names in UAE finance are the best known Wall Street brokerage and banking brands for the simple reason that their business models were built on a lethal combination of arrogance and ignorance - armies of unqualified commission salesmen aggressively flogging high risk stocks and bonds while skimming off some of the highest fees on the planet from clients. A simple proxy to evaluate the truth, of my observation is just to ask the executive managers of the disgraced brand investment houses exactly how many client lawsuits are pending against them in UAE. As per Nasdaq rules, information on legal action against brokers should be a matter of public record. But will you get an honest answer? No way.

It is clear that the bear markets have exposed the fact that most private banks in the Gulf, to borrow a phrase from T.S. Eliot, operated "business models of straw". In most cases, senior private bankers were hired on the principle of "who you know" not what you know". Major UAE investors tell me that the level of investment sophistication of the average resident private banker is so abysmally low that they would rather deal directly with London, New York or Geneva. The age of the NRI deposit salesman and the ex-retail banker posing as a global investment expert is now over but many UAE investors paid a terrible price for their client unfriendly recruitment philosophies.

Private banks in the UAE are also hurt by the technology driven "democracy" of information and investment advice. The average private banker in the UAE is a de facto full time money salesman who spends his time trying to attract client assets. A sophisticated client in the UAE is a de facto money manager, exposed to real time global capital markets intelligence.

There is simply no information arbitrage left between private bank and clients, a prerequisite for any fee based financial intermediation business. Beside, the Internet has made cut rate commission brokerage as easy as a mouse click.

Only a financial moron would pay $100 an equity trade to a private bank when the same trade can be executed on Datek or Ameritrade at $8 a ticket. Similarly why pay 5 per cent sales coast on a mutual fund you can buy for free on the net? The Internet is going to make the average private banker or broker who has no value added dimension extinct. That much, at least, is certain.

Many banks responded to the plunge in the stock markets by selling hedge fund products or capital guaranteed funds. Unfortunately, smart clients can access most hedge funds on their own with out any need for a private banker as a middleman. Why pay an extra layer of fees when most hedge fund managers have the exact same, far cheaper offshore funds in place?

The current vogue for capital guaranteed funds, unfortunately, took place when interest rates were at 40 years lows. Now that interest rates have begun to rise - the 10 year US Treasury note was up 50 basis points last week - the NAV of capital guaranteed funds is going to sink. Of course, this capital guaranteed funds mania was a bonanza for private bankers who pocketed 4 per cent fees from "financial engineering" (ie a phone call to your London investment bank who structures the option linked note) done at the client's expense.

It is obvious that UAE private banking needs a paradigm shift, a new strategic blueprint. The fault, dear Brutus, lies not in our stars but in the illogic of our flawed business models.