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Echo Partners Community Bank Blog

    A picture is worth a thousand words

    3 GroupsA picture is worth a thousand words…

    …That’s true with deposit profitability too. Especially when it involves how to translate deposit profitability numbers into more profit at your bank.

    Take a look at this graph showing individual account profitability starting from most profitable to least profitable.

    The 3 groups shown in the picture require very different handling. Let’s go through them 1 by 1.

    • Group 1 on the left includes your very highest profit accounts. Not only are they individually very profitable but they aggregate into over 100% of your bank’s total profit. You know how to handle them…Individual personal attention designed to further build your relationships. If you double their profit you will double the bank’s profit.
    • Group 2 on the right is the other extreme. They are the handful of your largest individual money losing unprofitable accounts. They also require individual attention to uncover and correct whatever is causing their lack of profitability (often excessive, expensive transactions not properly priced).
    • Group 3 contains the overwhelming majority of all your accounts. They fluctuate from profitable to unprofitable and include a lot of marginal accounts. There’s only 1 way to appropriately manage this many different accounts and that’s via account type changes.

    We’ll talk about that next time.

    What next?

    Results Concept. Word on Folder Register of Card Index. Selective Focus.-1What next?

    We’ve calculated our deposit profitability numbers and produced instrument-specific detailed P&L statements on each and every deposit account. Now what?

    Start with “Four Ds” segmentation based upon profit (vertical axis) and balance (horizontal axis) for each account. Make a simple 4 quadrant segmentation as follows:
    • Q1 is closest to the origin. Q1 has below-target profit and balances. We must decide how to fix Q1.
    • Q2 has higher balances but doesn’t meet our profit targets. We need to detect the cause and correct it.
    • Q3 meets our profit target despite having small balances. We want to develop Q3. They already earn profit for us so our goal is to grow their balances.
    • Q4 are our favorite accounts with both higher profits and balances. We want to defend these key relationships at all costs.

    Add the “Q-score” to your customer record and your client-facing staff can start using profit to make better decisions starting immediately.

    If someone walks into the bank requesting a price concession your rep looks them up on the system to see what sort of balances they carry. If they have big balances everything is set up to grant their request. But if they are a “Q2” (substandard profits despite higher balances) your staff might push back against that request.

    Stop treating everyone the same

    Hand with marker writing the word Do You Know Your Customers?Stop treating everyone the same.

    Some bank customers are better than others. And by better I mean more profitable. It’s time to start treating your customers based on their profitability.

    Businesses all across America do this. Airlines, grocers, pharmacies, casinos, restaurants…even the local sandwich shop. They reward their most profitable customers with extras and bonuses just for them. And they motivate and cajole their less profitable customers to prod them towards higher profitability.

    You should do the same at your bank.

    Make sure you endlessly reward your most profitable customers. And relentlessly push your less profitable customers toward higher profits. Simply by focusing on profitability you will improve it.

    But there’s just one problem…

    …You don’t know their profitability.

    Without knowing their profitability you risk rewarding and penalizing the wrong customers. That’s counterproductive.

    Don’t worry. This is easy to fix.

    Unlike all those other businesses you already have all the data you need buried deep within your core system. While you’ve been focused on other things your core system has been silently capturing all the customer data you need.

    It’s an easy next step to use it to calculate detailed instrument-specific P&L statements on each and every account.

    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.

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

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