* Wealth managers' profit growth suffers as costs soar
* As much as 100 hours of due diligence commonplace
* Number of client rejections on the rise
By Sinead Cruise and Chris Vellacott
LONDON, July 22 (Reuters) - Private banks managing thefinancial affairs of the world's wealthy face spending millionsof dollars every year on vetting new clients, as regulators gettough on banks that harbour tax cheats and money launderers.
While the world's rich are getting wealthier and puttingmore money into private banks, a growing proportion of the cashis from geo-political troublespots in the Middle East and Asia.
That is leading the banks, mostly based in Europe and theUnited States, to spend hundreds of hours on costly checks aimedat meeting regulators' demands to root out bad clients, eatinginto their profit margins.
Paul Kearney, head of Kleinwort Benson's private investmentoffice, said his team incurs between 5,000 and 25,000 pounds($7,600-$37,800) of costs in vetting each new client, dependingon the background intelligence required and the jurisdiction inwhich the research is undertaken.
"Currently the international client base is the fastergrowing so we would expect our costs to increase in the next12-24 months," he said, adding costs could equate to up to 10percent of the first year's earnings from that account.
Some in the industry question whether all the effort willmake much difference.
One London-based lawyer specialising in super rich clients,whose firm rejected one customer who turned out to be sellingrestored Soviet military hardware in the Middle East, saidsophisticated criminals would always be hard to identify.
"If someone wants to get through the process and they are aninappropriate person, they will almost certainly have thenecessary documentation and a front to get themselves through,"he said, speaking on condition of anonymity.
But with regulators cracking down on banks, and plans toprosecute individuals as well as their employers currently beingdiscussed in some countries, more money managers feel they haveto invest some of their profits in trying to reduce their risks.
"It is expensive, that is true, but you cannot think of itas it once was, because you cannot go back in time," said GeorgeKing, head of portfolio strategy at Royal Bank of Canada'sprivate banking arm, of the tougher vetting process.
"The burden for not doing it well or incorrectly, in termsof reputational risk or fines is both enormous and growing."
Top banks, including HSBC, have paid huge fines toU.S. lawmakers to make amends for unwittingly laundering Mexicandrug money, while Britain's Financial Conduct Authority hasfined three banks, including RBS's Coutts, for lax moneylaundering controls since its crackdown gathered pace in 2012.
FINANCIAL STRAIN
Increased vetting costs come on top of rising administrativeand regulatory expenses that have already made the competitivebusiness of wealth management much less lucrative for banks.
Data from the 2013 World Wealth Report compiled by RBCWealth Management and Capgemini shows the investable wealth ofthe world's so-called "high net worth" individuals rose by 10percent to a record $46.2 trillion in 2012, after dropping 1.7percent in 2011.
The flow of money into the $18.5 trillion global wealthmanagement sector increased 23.7 percent in 2012, reversing a27.9 percent outflow in 2011. However, average pretax profitgrowth was 5.3 percent in 2012, down from 12.3 percent in 2011,with high costs blamed for the dip, consultancy ScorpioPartnership said.
The cost of complying with regulation will continue to rise,according to PwC's annual Global Private Banking and WealthManagement Survey, published last month.
Respondents said they expected risk and regulatorycompliance expenses to account for seven percent of annualrevenue in two years, up from five percent today. Participantsfrom the Americas are bracing for even higher costs - roughlyequivalent to nine percent of revenues in the next two years.
"The ability to understand and manage the avalanche ofregulatory and risk issues ... will likely require private banksto continue investing heavily," said Justin Ong, Asia Pacificleader in PwC's global private banking arm.
Some banks have even resorted to rejecting accounts that aretoo small, risky or labour-intensive to turn a profit from.
"It is worth noting that the costs of the enhanced duediligence process may be incurred with the end result being adecision not to engage with the prospective client," KleinwortBenson's Kearney said.
For some in the industry, though, the battle againstcriminals comes down to a mix of experience and instinct.
"You have to be very confident of the origins of the fundsyou are dealing with. If not, it's very simple, you have to walkaway," said Rupert Robinson, CEO of Signia Private Wealth.
"You can do due diligence on a prospect to the 'n'th degreeand you might be able to find evidence of some bad behaviour butit is almost impossible to uncover things like fraud. If youhave any doubt, you just have to say no."
HSBC Holdings (HSBA)