<img height="1" width="1" style="display:none" src="https://www.facebook.com/tr?id=815305791870634&amp;ev=PageView&amp;noscript=1">

Echo Partners Community Bank Blog

    New accounts don’t add promised profits

    Piggy bank broken with money inside on white backgroundNew accounts don’t add promised profits.

    Too many bankers fall for the siren song of the new account conjurer. Why? Because we associate balances with profits and the number of new accounts is a metric that is measurable. We do the flawed math in our heads and expect newfound deposit riches.

    So although 50%+ of our deposits are unprofitable, we think spending money to get more of the same kinds of deposits will deliver improved profits. Or that paying expensive deposits rewards (to get customers to do more of what they already want to do) on pricey small accounts will result in greater profitability.

    What happens? The final results never quite match the front end promises.

    The reality is that unless you change your approach you’ll be locked into unprofitable deposits forever.

    You need a new target. Don’t just look for new deposits…Look for new profitable deposits based on the exact characteristics of your existing profitable customers.

    Start by measuring instrument-specific deposit profitability for each and every account. Then closely examine your profitable accounts for the specific behaviors that drive their profitability.

    Find more like them and you’ve got a good chance to beat the odds and add more profits instead of just adding more accounts.

    Don’t mistake balances for profits

    Blue & Yellow Tape MeasureDon’t mistake balances for profits.

    It’s easy to do. We’re so used to thinking of deposits using an aggregate measure like balances. We convince ourselves that balances are the be-all and end-all of deposits. As if balances told the whole story.

    The only problem is it’s just not true.

    Balances measure deposit quantity while profits measure deposit quality. I don’t know about you but I’d choose more profits over more balances any day. After all we can always get more funding but we can’t always whip up more profits.

    In a perfect world high balances would mean high profits, but we’re not living in a perfect world.

    Instead we’re in a world where bank staff rushes to offer price concessions to big depositors while depositors drop excessive numbers of high-cost transactions on us. Sometimes they work hard just to keep us from earning a fair profit.

    What’s a banker to do?

    The answer is to calculate instrument-specific P&L statements on each and every account. That way you’ll know on the front end just how profitable (or not) any given customer is.

    Once you know their profitability it’s a small step to knowing exactly how to handle almost any customer situation. With better info bankers make better decisions.

    Airlines and banking

    Airlines and banking

    I’m spending most of today traveling and couldn’t help but notice the similarities between airplanes and banking. Airplane seats pretty much all look the same, as do deposit accounts. But the truth is they all have different profitability.

    Airlines recognize this. They calculate profitability and adjust pricing dynamically all the time. They also track your flight activity, prices paid and profitability. Fly more, or buy a higher prices (higher margin) seat and you’ll immediately qualify for additional benefits.

    And airlines are also aggressive when it comes to converting previously free services to paid. Just think about early boarding access or checked baggage fees.

    Now you might like these changes or not but you have to admit airlines have had great success implementing them. We even help them by signing up for frequent flier accounts that let them run a P&L on each of us individually.

    Banks, on the other hand, lag behind in calculating individual customer profitability and using that info to better manage and grow profits. The irony here is that we already have all the data needed to make these instrument-specific profit calculations for each and every customer sitting unused within our core systems.

    We should put it to work growing our profits.

     

     

    Proof of concept

    Proof of concept.

    Try one account and see how easy deposit profitability can be.

    Just pick one and sit down with pencil, paper and a calculator. Start by listing the revenues the account can produce. Things like fee income and debit swipe interchange. Don’t forget the biggest revenue piece…the benefit of reinvesting those funds in loans and investments. Add it all up.

    Next list the direct costs involved. Things like interest paid, IT and personnel expense, plus some expense for every transaction made. Don’t include things like bricks & mortar or general overhead. Just direct costs of handling that account.

    Here’s a hint to keep you on the right track with transaction costs. If a transaction doesn’t require anybody to manually intervene (like an online transfer) make it cheaper. But if it does require a person to complete it (like a teller visit) make it more expensive.

    Get your data right out of the core system. Don’t worry about making it perfect. Just get it down on paper. Then add up all those transaction costs and subtract them from your revenues.

    Congratulations…You’ve just calculated your deposit profit (or loss).

    Now that you’ve proven it to yourself, calculate it for every account you have. You will see some surprising things when you start comparing the results.

    Manage profits with account types

    Manage profits with account types.

    Don’t worry about how to manage your deposit profits. Your bank already has the best tool to implement & manage deposit profitability…Account types.

    Account types govern all aspects of your deposit profits. They cover fees, minimum balances, allowed item counts and so on. That makes account types ideal for adjusting and growing deposit profitability.

    You just need to know 3 things:

    • Your deposit profit target.
    • Current deposit profitability.
    • Transaction type and volume details.

    Your profit target gives you something to shoot at. It’s hard to hit a goal you don’t set, and it’s even harder if you don’t track your status.

    That’s where current deposit profitability comes in. Deposit profitability tells you who’s making the grade and who is coming up short. It also tells you who will be impacted by account type changes.

    Transactions types and volumes are the building blocks for modeling your outcomes. Take the involved accounts, determine the cash flow changes associated with various changes to account type variables and figure out the fee/balance changes needed to reach your profit goals.

    The best part of using account types is that it is a set-it-and-forget-it process. Get the underlying numbers right and the results are baked in the cake.

    Deposit profitability is customer profitability

    Deposit profitability is customer profitability.

    If customer profitability equals deposit profitability plus loan profitability why do I focus on deposit profitability? Here are 3 reasons:

    • More of them: Banks typically have about 8 deposit customers for every loan customer. The sheer number of deposit accounts dwarfs the number of loan accounts. Despite your hopes the overwhelming majority of deposit customers will stay just that. Very few actually get loans.
    • Degree of profitability: Loans typically are much more profitable than deposits. We all recognize that even small loans should deliver more profitability then most deposits. Calculating deposit profitability delivers a bigger bang for your buck.
    • Banks already calculate loan profitability. You’re used to the idea and already do this to some degree. You might not be comfortable estimating credit costs but upcoming CECL implementation will fix this roadblock.

    A practical approach starts by calculating and segmenting by deposit profits. Identify the deposit accounts that are unprofitable or don’t meet your profit target. Then use loan status to guide your next steps.

    Don’t hesitate fixing unprofitable deposit accounts with no loans. If they do have lending relationships then go slow and consider a gentler approach.

    The profit/balance tradeoff

    The profit/balance tradeoff…

    …Helps efficiently segment your customers.

    Customers can have big balances or small balances. They can have high profitability or low. With these qualities you can get 4 possible quadrant combinations:

    1. Low profit, small balances. Lots of upside with no downside. Push aggressively.
    2. Low profit, big balances. These customers are 1 or 2 small decisions away from profitability.
    3. High profit, small balances. These customers are a “good fit” for your bank. Grow balances here.
    4. High profit, big balances. Keep them happy and ask for more.

    The beauty of these quadrants, or scores, is that you can easily append them to your CRM system so that client-facing staff understands customer status without getting bogged down in the actual numbers. This arms your reps with the information they need to make better day-to-day decisions without exposing sensitive profitability info.

    This type of nuanced treatment is just a glimpse of what’s available with deposit profitability. When you run the numbers on your customers you’ll see who is ripe for fee increases and who is more apt to respond to incentives to reduce transactions or grow balances.

    You can grow profit by increasing revenue, cutting costs or growing balances. It all works to build your profit.

    Fair is not the same

    Golf tees of different colors aligned in two rowsFair is not the same.

    Treating your customers fairly does not mean treating them all the same.

    Do you think you should give your absolute least profitable customers every benefit that you give to your very best most profitable customers? Of course not.

    So why do you continue to do this?

    The fair way to treat your customers is to reward them (or penalize them) based upon the actual behaviors they exhibit and profitability they deliver. Handling it any other way is not fair to either your customers or your bank.

    But to do this you need to be able to monitor and track customer profitability. And the truth is that right now you can’t do this.

    It’s a bit embarrassing that the sophisticated financial institution that you ask your customers to trust with their hard earned savings doesn’t have the same ability to track customer profitability that the grocer down the street or the local sandwich shop has.

    But you can change that narrative.

    You have all the data you need right there in your core system…Data to calculate detailed instrument-specific P&L statements for each and every account.

    Data that will give you customer insights, improve your decision making and grow your profits.

    All you need to do is decide you want to treat your customers fairly.

    What if banks didn’t take deposits?

    startup business people group have meeting in modern bright office interior, senoir investors  and young software  developersWhat if banks didn’t take deposits?

    Instead imagine all your funding came from wholesale sources…Things like FHLB advances, listing or brokered deposits.

    How would your bank be the same and how would it be different? Things the same are easy…You’d still earn income making loans and investments just like today.

    But just think about what would be different.

    You wouldn’t need branches, or at least they’d be a lot smaller and fewer, focused solely on loan production. No drive-thru lanes. No more ATMs, RDC or ACH to deal with. Wires would be limited to meeting your settlement needs. No cash collection, sorting or handling. You’d need a lot less staff and your IT needs would sharply diminish.

    Keeping this all in mind, and how much all of these services cost, do you still think all your deposits are equally profitable?

    Of course not! Accounts that create more transactions, especially transactions that require expensive delivery channels, are simply less profitable. Common sense tells you it’s so.

    You’ve already got core system data. So why don’t you calculate instrument-specific deposit profitability for each and every account?

    It’s easy, accurate and lets you treat customers based on their actual profitability. Reward them for being profitable. Charge them more if they’re running a loss.

    Balances or profits?

    Businessman pointing at whiteboard during a meeting in front of attentive colleaguesBalances or profits?

    What’s your deposit goal? Is it to accumulate the most balances or to earn the most profit? It makes a difference.

    Balance is an aggregate measure of deposit quantity. It’s easy to understand and we all need a certain volume of funding.

    There’s just one problem. All balances are not the same.

    Consider 2 seemingly identical deposits. Both have the same average collected balance (ACB), account type and daily cash flow pattern.

    But 1 uses hundreds of daily transaction via expensive delivery channels to create those daily CF patterns while the other uses just a single inexpensive online transaction. Which would you rather have?

    Which is more profitable? That’s an easy question…The one with fewer and less expensive transactions.

    Deposit profit depends on the volume of deposit transactions and the delivery channel used. But how do you measure this?

    The good news is that your core system has been quietly tracking these transactions and delivery channels. Only a simple extract, some transaction mapping and a few algorithms stand between you and a detailed instrument-specific P&L statement for each and every account.

    You could be well on your way to solving this issue in as little as a few weeks…With plenty of time to start recovering those profits before yearend.

    Do you want to grow your bank profits with little to no risk? Click Here to  Discover How

    Written by

    Subscribe to Email Updates

    Recent Posts