VOL. 5 NO. 3 | 2014
Special Report:
Evolving Deposit Analytics for Treasury,
Risk and Business Line Management
2015 Banking Performance:
Consumer Loan Growth Ahead?
Addressing the Branch Sales Crisis:
Four Keys to Improve Productivity
Re-thinking the Fundamentals of
Customer Relationship Pricing
Household Cash Management and
A Fresh Look at Onboarding
CONTENTS
Vol. 5 No. 3 | 2014
SPECIAL REPORT:
Evolving Deposit Analytics for Treasury,
Risk and Business Line Management
the Deposit
4 Integrating
Analytic Ecosystem
Leading banks are integrating deposit analytics into a single
ecosystem for applications, analytics and data. Splintered
efforts won’t suffice as performance pressures rise.
Peter Gilchrist and Steve Turner
Deposits and Liquidity
21 Commercial
Management: Strategies for an Era
of Change
To preserve deposit momentum in a future season of rising
rates, commercial banks will need to refine products, pricing
and sales force structure. Analytics will be key.
Michael Rice and Andrew Frisbie
24 CCAR PPNR Modeling
Improved modeling for pre-provision net revenue requires
strengthening the project framework, working to overcome
data sterility and testing alternative approaches.
Andrew Frisbie and Jonathan West
Coverage Ratio:
27 Liquidity
More Challenges Ahead
New regulatory liquidity standards will force significant
changes in how banks manage their balance sheets,
impacting both the treasury group and the business lines.
Peter Gilchrist and Steve Turner
Consumer Wildcard: Loan Growth Ahead?
9
Branch Sales Productivity: Four Keys to Improvement
14
With Onboarding, Cash Management Rules
18
Relationship Pricing: A Pragmatic Approach
30
2
LETTER FROM THE EDITOR
Editorial
Editor-in-Chief
Steve Klinkerman
Design
Design and Production
Brigid Barrett
Contributors
Letter from the Editor
Rick Spitler
Andrew Frisbie
Peter Gilchrist
Hank Israel
Treasury, risk and business line executives are facing a dual challenge in financial management: preparing for a rising rate environment while adapting to complicated new
regulatory requirements, some of which will change industry performance dynamics. In
recognition of this important transition, Novantas authors have prepared a four-part special report for this issue of the Novantas Review.
As detailed in our cover story, “Integrating the Deposit Analytic Ecosystem,” multiple
internal teams will need to pull together as the rate climate changes. An issue, however, is
that various units — product, finance, treasury and marketing — are using separate data
sources; separate analytics; and separate applications to address shared challenges.
More specifically to the commercial deposit business, banks are facing important
changes as the slumbering rate environment inches toward awakening and the business
is potentially rocked by new regulations that limit commercial deposit use for lending. As
discussed in “Commercial Deposits and Liquidity Management: Strategies for an Era of
Change,” an immediate priority is revising go-to-market strategy, both with product design
and pricing and with sales force structure and deployment.
With regulation, further impact on the deposit business is expected as banks implement the recently-finalized rules embodied in the Liquidity Coverage Ratio (LCR). As
detailed in “Liquidity Coverage Ratio: More Challenges Ahead,” most banks have work
to do in building foundational data and new performance metrics — critical in helping to
determine how the deposit business will need to evolve to maintain profitability.
Finally, the largest U.S. banks are working through complex new regulatory requirements for revenue modeling. One issue, however, is that the rush to meet statistical tests
for modeling pre-provision net revenue (PPNR) has left the new models divorced from
management performance drivers, as discussed in “CCAR PPNR Modeling.”
Elsewhere in this issue we explore key issues in retail banking, including branch sales
productivity, onboarding and relationship pricing. Fortunately, as detailed in our 2015
performance outlook, these challenges can be met in the context of continuing economic
recovery. The banking retrenchment phase is winding down, and that is good news.
Dale Johnson
Lee Kyriacou
Bryon Marshall
Sherief Meleis
Michael Rice
Adam Stockton
Steve Turner
Jonathan West
Marketing
Senior Marketing Associate
Katharine Davis
312-924-4467
[email protected]
Marketing Associate
Amelisa Dzulovic
Novantas, INC.
Co-CEOs and Managing Directors
Dave Kaytes
Rick Spitler
Corporate Headquarters
485 Lexington Avenue
New York, NY 10017
Phone: 212-953-4444
Fax: 212-972-4602
[email protected]
Subscriptions
[email protected]
212-953-4444
Steve Klinkerman
Editor-in-Chief
November 2014
3
COVER STORY
Integrating the Deposit
Analytic Ecosystem
Leading banks are integrating deposit analytics into a single
ecosystem for applications, analytics and data. Splintered
efforts won’t suffice as performance pressures rise.
BY PETER GILCHRIST AND STEVE TURNER
After some sleepy years of low rates and overflowing liquidity, the deposit
business is facing an intensifying environment, one that already includes
heightened regulatory scrutiny and ultimately will be roiled by rising
rates. While the exact timing of the next rate surge remains unclear,
industry leaders are preparing now, knowing that when rate do rise,
pent up depositor rate hunger will unleash a shopping surge that will
put accounts and relationships up for grabs — and impact margins.
4
A sophisticated understanding of deposits will be critical in
meeting this emerging performance challenge. In multiple
management areas connected with the deposit business,
executive teams are stepping up their analytic demands in
preparation:
• Product managers are looking for more accurate tools to
manage deposit pricing as customers seek higher returns
and the bank’s funding needs change;
• Chief financial officers are demanding improved
forecasting tools so they can better anticipate fluctuations
in balances and funding costs as rates rise;
• Treasurers and chief risk officers are under pressure to
field a new generation of sophisticated stress testing tools
to satisfy expanding regulatory expectations; and
• Marketing managers need improved targeting algorithms
and success metrics to match the right levels of spend with
the right customers and prospects.
These demands extensively overlap, with decisions in one
area of deposit management affecting outcomes in others. A
major issue that is surfacing, however, is that each constituency — product, finance, treasury/risk and marketing — is
trying to relate to the whole by using its own custom blend of
data and analytics.
The result is a growing misalignment in deposit management. Within most banks, different teams use different tools
that rely on different models with different metrics derived
from different data. Not surprisingly, teams get different
answers. Along with inconsistencies, errors and costly duplicative effort, the situation spells lost opportunity.
Consider stress testing. Pushed to the front of the development curve by regulatory pressure, these scenario analytics shed new light on customer behavior in stressed environments. Yet too many banks lock up the toolkit for stress testing
only, overlooking applications in areas such as interest rate
risk measurement, pricing and product design — not to mention planning and forecasting.
Such disconnects highlight the need to integrate the
deposit analytic ecosystem. Leading banks are already heeding the call. They are using integrated deposit analytics to
improve overall analytic accuracy; apply former silo-confined
findings and applications more broadly; align analytic results
by modeling from a single underlying “source of truth”; and
reduce cost by eliminating redundancies. Lagging banks
may not feel the consequences right now, but that will surely
change when rates rise.
Typical Disconnects
Deposit analytic integration is not an abstract concept, but
rather reflects a pragmatic need to rectify major disconnects
among the teams involved in deposit management.
One example is consumer deposit pricing. While the
product group typically manages pricing using sophisticated
November 2014
5
Integrating the Deposit Analytic Ecosystem
customer elasticity models and behavioral metrics, such
tools are rarely applied elsewhere. Typically they are disconnected from the treasury group, for example, which
separately assesses the likelihood of balance retention and
the influence of changing market rates on the bank’s own
deposit funding costs.
Another disconnect involves consumer and small business
deposit campaign scoring. Within the marketing group, these
models are heavily relied upon for key guidance on the return
on marketing investment, based on various segmentation perspectives, customer response estimates and offer acceptance
behavior. However, the metrics are rarely trusted outside of the
marketing group because the segment readouts and profitability estimates are often difficult to rectify with the finance group.
How do these silo disconnects occur? The problem starts
with the use of divergent analytic approaches to address
overlapping questions and activities, and gets worse as various management groups build their separate, inconsistent
data foundations.
At most banks today, the deposit analytic ecosystem
consists of a silo-managed collection of single-purpose
tools, each drawing on individually-defined and -calculated metrics. Teams are left with conflicting assumptions
on common questions.
Relationship “stickiness,” for example, has widespread
implications, reflecting the willingness of loyal customers to
maintain balances and shrug off market events, negative
publicity and competitive rate disadvantages. Though of
Figure 1: Designing the Deposit Analytic Ecosystem
Successful ecosystem design and development depends on a
clear understanding of how all of the parts fit together.
What are the Current and Emerging Applications?
Product
• Design offerings
• Develop rate strategy
• Manage day-to-day
rates
• Monitor performance
Treasury
Finance
• Conduct planning and • Assess funds sources
• Funds transfer pricing
forecasting
• Model rate scenarios
• Monitor performance
• Stress testing
vs. plans, forecasts
Marketing
• Optimize performance
• Targeted campaigns
• Rate negotiation
• Goals / incentives
What are the Supporting Analytics?
Metrics
• Cost-of-funds (incl. marginal)
• FTP-adjusted profitability
• Duration and average lives
• Core/non-core percentage
• LCR outflows
Models
• Elasticity curves
• Econometric balance, rate,
and fee models
• Beta forecasting
• Vintage-based balance decay
Tools
• Short-term pricing
• Long-term base and scenario
forecasting
• Stress tests (e.g., CCAR/DFAST)
• Historical performance analyses
What is the Right Data Foundation?
Internal
• Householded view of customer product ownership
• Behavioral history of balances and transactions
• Account-level price (rate and fee) history
• History of management actions (e.g., advertising)
by product, region, channel, segment, etc.
Source: Novantas, Inc.
6
External
• Peer deposit performance (balances, rates, fees)
• Macroeconomic conditions (e.g., GDP, yield curve,
growth patterns, stock indices, volatility indices)
• Externally-sourced wallet size and product usage
tags (notably for business customers)
Integrating the Deposit Analytic Ecosystem
shared importance to the product, finance, treasury/risk and imply that a single piece of software will support everyone —
marketing groups, stickiness is assessed separately by each rather that all needs should be considered when analytics are
team, which uses its own metrics, models and tools to support developed and the data environment is defined.
Analytics. Once the portfolio of applications is claridecision-making.
Typically each deposit-related management group uses fied, the next phase of investigation centers on the analytics
its own custom blend of internal and external data, accom- layer, which includes the metrics, models and tools that do
panied by special labels, definitions and groupings that are the heavy lifting. It is in this phase that numerous inter-silo
difficult to rectify with other silos. Algorithms that seek to inconsistencies and opportunities “come out of hiding,” so
categorize customer behavior by households often diverge, to speak, to become documented factors that can be disespecially when it comes to analyzing historical trend data. cussed, prioritized and treated in a collaborative setting.
One example is duraMeanwhile each silo uses its
tion, a metric that evaluown database structure.
ates changes in the value
One place where this
The Shape of Success
of deposits relative to flucfragmentation has hit home
tuations in market interrecently is regulatory stress
est rates. Often today, the
testing, which entails the use
An effective integrated deposit analytic ecosystem:
product group uses its own
of detailed time series analy• Has a clearly understood goal
duration metrics for pricing.
ses to assess the bank’s expo• Relies on single-source-of-truth data
Meanwhile the finance group
sure to potential crisis sce• Minimizes redundant calculations
uses a separate set for profnarios, such as a market rate
• Meets current constituent needs
itability forecasting. Off in
shock. When internal com• Is flexible enough to adapt to changing demands
another corner, the treasury
pliance teams got to work,
• Engenders trust throughout the bank.
group has its own duration
many found that various silo
metrics for funds transfer
databases had unacceptably
—Peter Gilchrist and Steve Turner
pricing. Meanwhile the marshort time series. Teams were
keting group relies on yet
left pulling together data at
the last minute with duct tape and wires. Then stress-test results another set of independent duration calculations to assess
campaign profitability.
did not foot with business reporting, hurting credibility.
Duration metrics should be defined consistently and measured by a single model, which will greatly facilitate cohesive
Integration Agenda
In charting a course to migrate the organization and establish decision-making within the deposit analytic ecosystem. This
a more integrated deposit analytic ecosystem, executive man- holds for a number of other key metrics as well.
Data. After sorting through applications and analytics, the
agement will face three major considerations: applications,
analytics and data. Taken in sequence, these factors become stage is finally set to establish a common data layer for the
project phases that permit a multi-silo review of practices, deposit analytic ecosystem. This is the common data mart that
all constituencies will eventually draw from and augment. It
requirements, issues and opportunities.
Applications and stakeholders. Across the four domains pulls data from multiple areas into a single source that can
of treasury, line of business finance, marketing and products, support all deposit analytics.
The primary data elements are internal account- and custhe typical large institution can readily identify more than
a dozen important analytic applications related to deposit tomer-level details, including transactions. This is augmented
management. Examples include stress testing; funds transfer with external elements such as competitor pricing and macropricing; financial planning and forecasting; marketing cam- economic data.
The consistency benefits of a common data layer are obvipaign optimization; and product design and rate strategy.
Also each group will have a “wish list” of new applications to ous, but key challenges often block its achievement:
• In a more technical realm, difficulties include ensuring
be developed in the future.
consistency of source data over time; enhancing raw
Reviewing the applications in composite sets the context
data with analytically-derived behavioral insights; and
for integration and facilitates the dialogue among group leadmaintaining proper linkages between data sets.
ers. What is the target state? What applications are needed,
and when? Developing this application inventory does not • Management practices can also be problematic — for
November 2014
7
Integrating the Deposit Analytic Ecosystem
example, the central data support team is often measured
on cost control and typically operates with limited
resources. This leads to perennial issues with static data
that is difficult to access, motivating individual business
groups to build their own data marts.
To overcome such data-related issues, the business requirements and functional specifications for the ecosystem need to
be translated into a plan to establish a populated data repository. This includes the business plan; resource requirements;
organizational positioning; systems infrastructure and ongoing repository management; and oversight.
greater advantage of projects already underway. For banks
with more advanced deposit analytics, the focus of an integration project is to rectify key inconsistencies among their
advanced but loosely-connected units.
Either way, stress testing activities may help to advance
the cause of integration, given that the majority of deposit
analytic dollars being invested today are allocated to stress
testing. A common goal will be to leveraging these investments to help advance the bank toward the integrated vision.
There are solid international precedents for this approach.
In both the United Kingdom and Australia (both markets with
structurally higher loan-to-deposit ratios), banks have used the
data and analytics initially required for regulatory compliTransition Plan
After setting a vision for the integrated ecosystem, a key ance to support a broader business agenda around improved
question is the transition plan. What is the best way to deposit analytics.
Another issue is governance, which can be challenging
make needed improvements while conserving resources and
assuring business continuity? Clearly an agile development throughout the process. There are many constituencies within
deposit management and each group has its own objectives.
approach will be needed.
Often the answer is to incrementally move the bank along While current governance structures (e.g., capital budget
the path, both through select investments and also by taking committees) can address spending approval, they do nothing
to empower an organizational champion.
To break this logjam and provide a
Figure 2: Governance Structure
management focal point, often the best
answer is to create a sub-group housed
The deposit analytics sub-committee guides advancements that will
within the asset-liability management
support all constituencies.
committee (ALCO). This is a logical
home for the new “deposit analytic subcommittee,” given ALCO’s responsibility for deposit strategy and execution,
ALCO
and cross-constituency membership (See
Figure 2: Governance Structure).
Integrating deposit analytics may
Deposit Analytics
sound like a tall order, but banks in other
Sub-Committee
markets have achieved this important
goal. North American banks that crack
this code will be positioned for superior
Charter
Members
deposit performance in the coming era
• Challenge current deposit
• Head of deposit products
of rising rates — and will be much more
analytic practices (e.g., silos,
• Treasurer
confident in their ability to forecast and
differing assumptions)
• Senior planning officer
manage their balance sheets.
• Set priorities for deposit
• Senior business line
analytic advancements
representation
• Responsible for budget
• Chief information officer
requests and adherence
• Chief risk officer
• Oversee implementation of
Peter Gilchrist and Steve Turner are Managing
advancements
Directors at Novantas Inc., a management
Source: Novantas, Inc.
8
consultancy based in New York City. They can be
reached at [email protected] and
[email protected], respectively.
Consumer Wildcard:
Loan Growth Ahead?
BY LEE KYRIACOU
As banks look to differentiate performance in 2015, a major question is whether consumers
are finally ready to pick up the pace of borrowing.
Finally, after a deep recessionary trough and a painfully slow
and uneven recovery, the long-awaited economic expansion
has begun. After a three percent increase in total loans held
by the U.S. banking industry last year, institutions are on track
for five percent loan growth in 2014, and we expect to see
the pace accelerate slightly in 2015.
Commercial lending continues to lead the way. The
category of commercial and industrial (C&I) lending was
the quickest to contract during the recession and the first to
recover, along with secured asset-based lending. Commercial
real estate lending has now returned to a healthy growth
rate, and construction and development lending seems to
be stabilizing after a lengthy contraction. We expect strong
commercial growth in 2015 with expansion rates ratcheting
up from 2014 in all categories.
That is good news, and the question now is whether
consumers are finally ready to pick up the pace of borrowing as well. Home mortgage and even credit card
balances are inching up after a six-year decline. And a
trough may be nearing in the long-troubled category of
home equity lines of credit, with at least a bit of growth
expected next year.
While it is far too early to call a major turn, banks will
be keenly watching housing credit going into 2015, alert for
November 2014
9
Consumer Wildcard: Loan Growth Ahead?
Figure 1: Improving Household Trends
U.S. consumers have more confidence and equity in their homes, and unemployment is falling. However,
hangover effects from the recession likely will continue to temper the pace of borrowing and spending.
10.0%
Une
mpl
80
oym
ent
7.5%
nt
entime
er S
Consum
60
$33
$33
5.0%
lue
y to Va
quit
Home e
40
2.5%
20
4Q03
U.S. unemployment rate
Ratio of home equity to housing market value (%)
University of Michigan Consumer Sentiment Index
100
0.0%
2Q05
4Q06
2Q08
4Q09
2Q11
4Q12
2Q14
Source: Novantas analysis of Federal Reserve data, U.S. Bureau of Labor Statistics, Thomson Reuters — University of Michigan Consumer
Sentiment Index (1st quarter 1966 = 100).
any opportunities to rebuild momentum in this former engine
of growth and profitability.
Some positive supporting trends continue to progress,
including gains in employment and consumer confidence
and a recovery of home equity as housing market values rise
(Figure 1: Improving Household Trends). But there are braking factors as well, including uneven recovery in regional
markets and among income groups, suggesting selective
opportunity instead of broad expansion.
Overall, banks still face challenges in restoring pre-recession levels of return on equity and assets. Factors include the
slow market for housing-related credit; continuing compression of interest rate margins; and the expenses and complexities of transitioning to a multi-channel marketplace.
Again in 2015, this leaves banking companies to face
a revenue-challenged environment where growth is more
10
about market share gains — winning at the expense of competitors. Leaders will be distinguished by higher-than-market
loan growth, funded by more stable and lower-cost deposit
sources.
Outperforming both with lending and funding will
require sharper analytic skills. This includes better segmentation and targeting of customers with the right offers. It
also includes smarter loan and deposit pricing to optimize
growth while preserving margins and risk-adjusted returns.
Elsewhere, analytics will play a key role in rapidly reconfiguring branch and electronic channels to manage down
physical cost while improving sales effectiveness.
Household Sector
Auto lending has been the one bright spot on the consumer
side, recovering earlier as consumers could not put off car
Consumer Wildcard: Loan Growth Ahead?
“Outperforming with lending and funding will require sharper analytic skills. This includes better
segmentation and targeting of customers with the right offers . . . also smarter loan and deposit pricing to optimize growth while preserving margins and risk-adjusted returns.”
purchases indefinitely. But housing-related loan balances
have languished as residential real estate went through a
painful correction.
Going forward, we expect to see increasing growth in
HELOC originations, but only modest growth in consumer
credit card balances. Residential borrowing likely will
remain uneven, both geographically and demographically,
with outsized portions of growth coming from the local housing markets that are more fully recovered, and from home
purchases among higher-income families.
Next year’s outlook for consumer and residential borrowing is heavily influenced by aftershocks from the crash
of five years ago, and it is helpful to review some of the
chronology to see these influences at work. Chief among
them is housing equity, which affects more than three fourths
of all consumer borrowing.
On paper, the rapid run-up in housing prices of a decade
ago provided what seemed to be an ever-growing cushion
of home equity, or market value in excess of outstanding
loan balances. Peaking at roughly 60% of the total value of
the average home in 1995, this cushion encouraged rampant borrowing with results that are well known.
When the real estate bubble burst, the collective homeequity-to-value (HETV, or the inverse of bank loan-to-value
(LTV)) plummeted to less than 40% and stayed there for three
long years. Consumers halted unnecessary spending (e.g.,
reducing credit card purchase, holding cars another year)
and paid down debt wherever possible — not just in HELOCs
and mortgages, but across the board. The lone exception
was student lending, a category that is now served largely
by direct federal lending.
Looking to next year, the good news is that recovering
Questions for Mid-size and Community Banks
The specifics of how to improve loan growth while preserving
stable funding will vary by bank size, business composition and
market position. But some clear questions stand out for midsized regionals and community banks largely engaged in local
intermediation, or classic deposit-gathering and lending in the
local footprint:
• How to win in local commercial lending without compromising pricing and underwriting?
• How to keep the distribution franchise relevant and
effective?
Mid-size regional and community banks are predominantly local commercial lenders. The traditional differentiator
for smaller banks was deep local relationships. But commercial
lending spreads have fallen consistently and considerably in
recent quarters, forcing many competitors to fall back on price
to win business.
Here, smaller banks must develop additional differentiating
levers. These include developing superior knowledge of customers and refining local market pricing; smarter negotiating tactics for relationship managers; improved treasury management
products; and more consistent relationship building.
With deposit gathering, local banks face both demand- and
supply-side issues:
Demand side. Consumer channel preferences are evolving
away from the local branch and toward online channels. And the
proliferation of remote deposit capture is eliminating the last
piece of paper that required customers to come to a local branch.
Supply side. Smaller regionals are surrounded by formidable competitors, including national banks with extensive branch
franchises; a new generation of direct banks with powerful
brand names; and credit unions with both local appeal and a
not-for-profit business model. Here, smaller regionals must find
ways to modestly refresh their core local branch networks while
still offering adequate e-channels.
Personal touch and service will remain at the forefront of
differentiation, and these attributes must translate into effective
in-branch sales, coupled with new ways to reach local customers.
This will be no mean feat for smaller regional banks, but essential if they wish to avoid ending up with higher deposit rates as
the sole lever in the competitive hunt for funding.
— Lee Kyriacou
November 2014
11
Consumer Wildcard: Loan Growth Ahead?
home values have buoyed home equity significantly. From
the trough of 37% in first quarter of 2009, collective HETV
climbed to 54% by the second quarter of 2014. This trend
should help contribute to rising growth in all consumer
loan categories.
Also there are helpful trends in employment and consumer confidence. From a nearly 10% peak in late 2009,
the U.S. unemployment rate had fallen to 6.1% at midyear
2014, according to the U.S. Bureau of Labor Statistics.
Meanwhile the running survey of consumer sentiment sponsored by Thomson Reuters and the University of Michigan
saw the midyear reading on its index
climb from 56.4 to 82.5 between
2008 and 2014.
But now for the post-recession braking factors:
• First, the recovery is uneven,
with income growth and housing
appreciation skewed to higher
income
brackets
and
more
expensive homes.
• Second, while unemployment is
down, there is significant “underemployment” and wages have not
picked up.
• Third, while consumer confidence is
approaching pre-crisis levels, a good
deal of residual borrowing caution
is to be expected from individuals
and households that felt the full brunt
of the Great Recession. Though not
as profound as the Great Depression of 1929–1939, the
hangover effect is real and will last for quite some time.
• Finally, much of the housing recovery is related to the
historic low interest rates engineered by the Federal
Reserve. When rates eventually rise, further home value
appreciation will encounter major headwinds.
All in all, this paints a more modest picture for consumer
loan growth. Opportunity will go to the banks best able to
pick through the market and find it; others risk losing more
market share and will feel the greatest pressure to further
reduce costs.
Looking forward, we do not expect to see Fed policy
affect overall deposit balance growth through the end of
2015, though the onset of rising rates toward midyear will
start having modest impacts on which sector holds deposits, and at which banks. As loan growth continues, the
primary balance sheet impact will be the substitution of
loans for securities, as opposed to major changes on the
funding side.
Net interest income will improve primarily on the
strength of loan expansion, with no help from net interest
margin in the near future. As for non-interest revenue, there
are significant headwinds from further
regulation and the end of the mortgage
refinance boom. Those banks with
ancillary fee businesses — capital markets, advanced treasury management,
brokerage/wealth management and
insurance — will enjoy fee growth, but
classic intermediation banks will not.
The industry has been working to
push down operating expenses, but
next year’s improvements in the efficiency ratio likely will come from revenue growth rather than a further round
of cost cuts. One offset is that part of the
added revenue will be diverted to loss
reserves, necessary to cover expanding
loan portfolios.
While these expansionary benefits
will increase industry profitability, investor returns will still fall short of pre-crisis
levels. Even with increasing stock buy-backs, the industry is
carrying a boatload of capital that is difficult to fully leverage in the current environment, leaving muted returns on
equity that typically will not exceed 11%.
“Rising home values have
buoyed home equity significantly. From the trough
of 37% in first quarter of
2009, collective home-equity-to-value (HETV) climbed
to 54% by the second
quarter of 2014. This trend
should help contribute to
rising growth in all consumer loan categories.”
Industry Fundamentals for 2015
Deposits have been growing far faster than loans for quite
some time, leaving the industry with a record low loan-todeposit ratio and starved for earning assets. But the situation is easing as healthier loan growth begins to outpace
deposit expansion.
12
Catching Up and Differentiating
With economic trends progressing (even without a significant acceleration of consumer lending), banking executives can take a quick breath and try to deal with some
deferred issues — clean up or catch up. While the particulars will vary by individual bank, there are some common
industry challenges:
• First, there are the remaining non-performing home
mortgages — whether currently carried on bank balance
sheets or being put back to originators.
• Second is fully implementing new compliance requirements,
including more robust modeling for the Fed’s Comprehensive
Capital Analysis and Review (CCAR).
Consumer Wildcard: Loan Growth Ahead?
• Third is tending to deferred investments in systems.
• And last but not least, there are the write-offs associated
with reconfiguring the increasingly underutilized
branch system.
Investors have already set expectations for certain
improvements and will be demanding new levels of differentiated performance from the best banks. As credit concerns continue to abate, stock market valuation for banks
will more purely center on superior growth and profitability.
For those banks where ROE and ROA are visibly below
the industry norm, further near-term cost reduction may be
the first order of business. But for most banks, aspirations for
improved performance will center on outgrowing the market, helping to leverage a stable expense base. Obviously
there will be winners and losers.
In particular, we believe the differentiators of bank performance will be twofold:
Superior loan growth. Beating the market pace of growth
will be the clearest way to gain higher valuations from investors. That growth may come from either better positioning in
higher-growth loan categories (C&I, CRE, auto, HELOC) or
from taking share, and from either new customer acquisition
or deepening current relationships — but not at the expense
of spreads and credit quality.
Stable low-cost funding. To preserve net interest margins
as loans grow, banks must manage their funding sources.
This includes garnering deposits without overpaying, especially as interest rates begin to rise, and looking for ways to
attract and retain more of the stable core deposits that are
now heavily emphasized under Basel III.
Lee Kyriacou is a Managing Director at Novantas Inc., a management
consultancy based in New York City. He can be reached at lkyriacou@
novantas.com.
Precision Performance
For all banks — particularly the larger banks with multi-regional footprints and some national business lines — there are
growing skill requirements that fall under the heading of precision management. These skills revolve around using data-informed analytic approaches to improve decisions, investments
and pricing.
Differentiation, segmentation and targeting. Better identification of target customer segments is a foundational component
in superior lending and deposit-gathering. On the commercial
side, this applies to lead generation and cross-sell prioritization,
both hinging on an understanding of potential customer wallet for banking services. On the consumer side, the emphasis
is on aligning comprehensive product sets with key customer
segments, as well as smarter direct-to-consumer marketing.
Smarter loan and deposit pricing. Just as knowing which customers should or should not be offered credit provides advantage, so too does knowing which customers do or do not require
better pricing. On the commercial side, price sensitivity analysis
provides the relationship manager with the best information and
guidance to negotiate commercial loan products and relationships. On the consumer side, it optimizes rack-rate and lifetime
relationship pricing for deposits and loans. In all cases, precision
pricing is the key to expanding both sides of the balance sheet
without overpaying.
Channel and sales reconfiguration. The franchise realignments of
the larger regional and national banks are more complex. Clearly
there are consolidations within markets, but there are also considerations with branch redesigns; hub-and-spoke branch options;
and small business service models — as well as market-by-market
optimization of automated teller machine networks, advertising
and brand presence. There is also work to be done in analyzing
and redesigning sales efforts, both in-branch and direct, to recover
lost productivity and improve returns.
Fee and consumer lending revenue. Larger banks must expand
their sources of fee revenue as well as their access to consumer
lending markets. Much of this diversification will come from
standalone ancillary businesses — mortgage, indirect auto,
capital markets, wealth/brokerage and insurance. But banks
also must be bold enough to innovate with unsecured lending
options for their core relationship customers.
Branding savvy. With online browsing becoming the preferred channel to research financial products, the bank brand is
more important than ever before. A comprehensive and adaptive
branding strategy that covers markets, segments and products
— both physical and online — is now a requirement for better
multi-regional and multi-channel performance.
— Lee Kyriacou
November 2014
13
Branch Sales Productivity:
Four Keys to Improvement
BY DALE JOHNSON AND BYRON MARSHALL
In a crisis era for branch sales, banks need forward-looking strategies that can anticipate
changing conditions, accommodate local markets and adapt to a multi-channel climate.
One of the most important management challenges in retail
banking today is the crisis in branch sales effectiveness.
Across the industry, executives are keenly aware of ongoing
declines in branch customer traffic, sales volume and staff
sales productivity, yet frustrated in their attempts to stabilize
the business. Is there a better way?
So far the industry has pursued three main avenues of
response, but each has proved problematic. Calling and lead
management programs have proved inadequate in jump-starting sales. Staff performance pressure has been applied via traditional programs with sales goals and incentive, but with little
effect. And system-wide efforts to deploy highly skilled sales
representatives in each branch have not paid off.
The situation calls for fundamental revisions in branch
sales strategy. Instead of coping tactics, it is time to reposition for a permanently changed market. There are four major
dimensions of this effort:
First, retail banks will need an enhanced understanding of
market opportunity for each major locale within the network.
Along with variations in customers, competitors and comparative network presence, there are the varying influences of
digital presence and marketing spend, both critical in driving
high-value traffic to the branch.
Second, improved market guidance needs to be put to
work in refining resource allocation and goal-setting across
the network. Many banks are losing significant opportunity
by under-nourishing and -goaling high potential markets,
while over-investing scarce sales and marketing resources in
less promising locales.
The third priority is improving traffic pull and relationship
expansion. This includes strengthening web interaction with
shoppers to drive high-value branch sales traffic that cannot
be captured by pure street corner presence. It also includes
14
improved onboarding and outbound calling programs.
Finally, management and performance metrics are in serious need of overhaul. Product count falls woefully short in
measuring progress, and the inclusion of balance formation
still paints only a partial picture. A clearer metric is return on
salesforce (RSF), or the total sales value created in the network relative to the investment in sales capacity.
Market Opportunity
Within the total portfolio of branches in a network, typically
there are major categories of outlets, each having distinct
sales characteristics (Figure 1: Differences in Branch Sales
Profiles). Each branch archetype captures value differently
and provides different levels of return. Mapping these differences is a crucial first step in determining how to address
sales underperformance:
Acquisition branches. Based on our review of more than
10,000 branches nationally, nearly a fourth of all branches
typically derive more than 60% of their sales from new-tobank customers (less than 90 days’ tenure). These branches
bring in a lot of new checking customers, but RSF is much
lower as they build the book of business.
For management, this translates into a sales staffing
emphasis on continuing to drive acquisition while minimizing new customer churn. Given that acquisition branches
will skew towards relatively simple, lower-value products,
management also has more leeway in using lower-tenured
platform staff who can easily address these customer needs.
Lower-tenured staff are also less expensive, better supporting
the economics of acquisition focused branches.
Acquisition-intensive markets will continue to need marketing support to sustain momentum and visibility. Also in
order to capture the fullest possible value of new customer
Branch Sales Productivity: Four Keys to Improvement
relationships, management will need robust programs to help
drive activation as well as product penetration. Effective follow-up programs and tools are essential to track and contact
customers in the critical 90-day onboarding window.
Cross-sell branches. Representing nearly one-fifth of the
total, cross-sell branches have sharply lower results in new
customer acquisition, but they lead the pack in cross-sell with
established relationships. These outlets have the highest sales
productivity as measured by sales per FTE per branch, and
also the highest return on salesforce, reflecting superior results
in generating high-value account originations.
High cross-sell branches are prime candidates for the
deployment of higher skilled, highly active sales staff that can
mine the current customer book for additional opportunities
and drive outreach efforts to acquire new customers. These
skilled sales representatives have a priority need for effective
customer analytics and lead qualification/generation tools,
supported by a strategy for targeted relationship expansion.
Otherwise they cannot fulfill their potential.
Cross-sell branches better justify the investment in longer
tenured staff having a deeper understanding of complex
products, both in terms of meeting customer needs and also
in terms of potential returns generated by successful cross-sell.
High cross-sell branches can also benefit from the assignment
of specialized sales personnel (e.g., wealth, small business,
mortgages) to deepen product competency in the branch.
Mixed branches. The remainder of branches — nearly
60% of the total — are closer to an even split in sales coming from new-to-bank customers versus cross-sell with established relationships. These branches tend to have middling
performance characteristics, both in productivity and return
on salesforce.
The mixed branch archetype comes closest to the traditional “cookie cutter” view of branch banking and, at least in
the short term, requires the least change. This gives management the opportunity to focus elsewhere, on the more bifurcated acquisition and cross-sell branches, where the opportunity is greatest because of the customer mix. Mixed branches
still require continuous monitoring, however, so the bank can
act when units are propelled to another sales archetype by
shifts in customer demographic or other factors.
This type of archetypal analysis takes on added significance when overlaid on a comprehensive analysis of the
micro-markets served by clusters of local branches. Our
research shows large variations in opportunity based on
factors such as customer segment profiles, trends in account
Figure 1: Differences in Branch Sales Profiles
“Acquisition branches” need sales staffing to support a high volume of new business, while “cross-sell
branches” need a staffing emphasis on skilled relationship expansion.
Branch Sales Archetypes*
Acquisition
Mixed
Cross-Sell
24.4%
57.2%
18.4%
2.6
2.8
3.4
$220,027
$235,310
$228,040
Sales per branch per month
51
57
63
% of total sales derived from
new-to-the bank customers
62%
43%
25%
% of total sales derived from cross-sell
to current customers
38%
57%
75%
Sales FTE per branch
2.2
2.5
3.0
% of branches
Return on sales force (RSF)
Average NPV of sales production
per FTE per year
* Sales archetypes are based on a review of more than 10,000 branches nationally.
Source: Novantas 2014 SalesScape Branch Productivity Study.
November 2014
15
Branch Sales Productivity: Four Keys to Improvement
turnover, and digital and marketing presence.
Resources and Goals
Branch sales staffing has long been more art than a science.
In many cases yet today, decisions are based on a mix of intuition, extrapolations based on prior-year results and a need to
meet top-down sales goals. At best, some institutions are starting to include basic market factors such as projected growth
in loans and deposits.
Then with field implementation, sales staffing models are
further handicapped by a powerful tendency toward uniformity. Built into many models is a continuing assumption that
various regions, micro-markets and branches have roughly
the same performance potential and staffing requirements.
Evidence of this can be seen in our most recent branch
productivity study, which shows only slight differences in platform staffing between branches in high-opportunity markets
and those situated in less promising locales. There is a similar
lack of variability between the highest and lowest performing
deciles within individual networks.
Combined with uniform sales goals, the situation has
left many banks unable to effectively allocate sales staffing
resources and assign targets to maximize sales. In some
instances, this leads to situations where branches and branch
managers are meeting or exceeding their standardized sales
goals, yet underperforming in relation to the potential in their
market. Elsewhere, teams may be doing a great job of winning business in less attractive markets, but graded as sub-par
in relation to uniform corporate targets.
Going forward, the goal should be to equip planning models with a degree of adaptability commensurate with the variation of micro-markets within the network footprint. Staffing
must vary based on the opportunity in each micro-market.
And sales goals must be reconciled from the bottom up to
insure that they stretch individual branch performance while
still meeting overall bank growth goals.
For this to work, the bank needs an enhanced understanding of micro-market opportunity, based on a broad
Figure 1: Differences in Return on Sales Force (RSF)*
Many branches struggle to generate returns to cover the investment in the branch sales force, often because
the quest for pure unit sales wins out over driving the right mix of volume and value.
Breakeven return
on sales force
Average # of sales transactions per non-teller
FTE per day**
* Return on sales force (RSF) is expressed as a ratio. The numerator is the value generated from sales on a net present value (NPV) basis.
The denominator is the cost of the sales resources needed to generate those returns. For example, an RSF of 2X indicates that the NPV of
sales return equals twice the outlay for sales resources. The RSF metric provides key guidance on the quality of sales (as expressed in NPV),
as opposed to the pure unit-sale volume metrics often used today. ** Calculations exclude credit card transactions.
Source: Novantas 2014 SalesScape Branch Productivity Study.
16
75% of branches
5X
RSF
31% of branches
$36 2X
RSF
4X
RSF
13% of branches
$33 1X
RSF
3X
RSF
4% of branches
Estimated
average
net present
value per
sale per
day**
7% of branches
Relationship of Average Sales Value to Sales Productivity
Branch Sales Productivity: Four Keys to Improvement
spectrum of variables across segments and product groups
(deposit, credit, mortgage, etc.). In turn, insights can be used
to engage internal stakeholders and optimize the sales capability of each branch in the network.
Traffic Pull and Relationship Expansion
Pulling high-value sales traffic into the branch and improving wallet penetration will help to leverage sales staff as
“organic” walk-in business continues to dwindle. The new
sales orientation will center on proactive outreach, as
opposed to passive capture.
Marketing will play an integral role. Both at the macroand micro-market level, it can be used to increase customer
awareness in the marketplace and drive high-value traffic to
the branch — particularly for new-to-bank customers.
Digital effectiveness is also key, given that most branch
originations are now preceded by customer online shopping
and research. In many cases the visibility and functionality of
the bank’s public web site needs to be strengthened. There is
also a need to optimize the customer transition from online
consideration to in-branch purchase.
Another key lever is outbound calling for branch sales
staff — not the primitive outreach often seen today, but a
robust lead management and referrals program that includes
targets for calls and appointments and aligns activities with
profitable results. The call center can also be leveraged to set
appointments for platform staff in the branch.
There is also more that can be done with relationship
expansion and cross-sell, both during the initial onboarding
period and over the life of the customer relationship. Branch
sales staff will continue to play a critical role in steering new
customers into core cash management products, and also in
encouraging activation and usage of new accounts. In turn,
usage of core banking services will provide entrée for branch
platform staff to meet higher-value customer needs over the
life of the relationship.
Measuring for Value
Banks primarily have used two types of performance metrics
as a yardstick for evaluating performance — volume-based
and balance-based. But focusing too narrowly on either of
these areas can create the wrong incentives and focus salespeople on the wrong products.
A better metric is the total value created in the network
relative to the investment made in sales capacity, or return
on salesforce. RSF can identify all sorts of imbalances and
opportunities that otherwise are often overlooked (Figure 2:
Differences in Return on Sales Force (RSF).
Another key measurement involves the sales funnel, or
the end-to-end journey that takes the customer from awareness; to consideration; and finally to purchase. Today most
banks only measure the end of the funnel, as reflected in
originations per full-time equivalent sales staff; per branch;
or per product. But given the increasing complexity of the
buying process, end-stage metrics do not provide enough
information to fine-tune the process, and can lead to incorrect assessments of network performance.
Funnel leakage is a critical measure, providing insight on
how and why customer inquiries ultimately succeed or fail in
producing sales. If findings cannot be assembled from current
internal data, they can be derived via market research (akin
to caller-based customer satisfaction surveys).
With the web’s aggressive intrusion into the sales funnel,
issues in productivity can arise before the sales staff gets to
interact with the client. Solving those “upstream” issues may
hugely impact productivity in the branch (e.g., offers made,
consideration rates, shopping rates, etc.).
New Mindset
Managing branch sales productivity was far less complicated
back when consumer demand was much stronger, branches
carried most of the load in marketing, service and sales,
and planners were mostly concerned with small, incremental
changes in customer demand and behavior. Now there is a
pressing need for forward-looking strategies that can anticipate changing conditions, accommodate local markets, and
adapt to a multi-channel climate where branch sales influences increasingly reside outside of the branch.
Dealing with this strategic productivity problem will
require a change in mindsets and behaviors throughout the
retail distribution channel. Otherwise banks will fall further
behind with operating models, sales expectations and sales
management systems that are set up to deal with yesterday’s
situation…not today’s.
The good news is that a series of specific steps can be
taken to address the challenge. These include adapting strategies for local markets; tailoring staffing resources and goals
in accordance with opportunity; boosting traffic pull and relationship expansion; and incorporating new performance metrics for decision-making. For progressive retail banks, this is
the sales productivity management agenda for 2015.
Dale Johnson is a Managing Director and Byron Marshall is a
Principal in the Chicago off ice of Novantas Inc., a management
consultancy. They can be reached at [email protected] and
[email protected], respectively.
November 2014
17
COMMENTARY
With Onboarding, Cash Management Rules
Many retail banks are missing the chief goal of onboarding, which should be to
establish the bank as the customer’s primary cash management provider.
BY RICK SPITLER, SHERIEF MELEIS AND HANK ISRAEL
A
re retail banks building strong
foundations for cross-sell or
forfeiting major opportunities?
A lot depends on the approach to
onboarding, a set of activities aimed
at cementing and expanding new
customer relationships.
Onboarding has received more
than a decade’s worth of attention
and extra effort. The best programs
are quite formal, replete with detailed
18
routines for customer contact, communications and product introductions.
But questions are surfacing about
the orientation and objectives of
these programs. Often, performance
pressures lead to a hurried shortterm focus on “selling what we can
while we can,” with far less foundation-building than is needed to set
the stage for a profitable cross-sold
relationship over the long term.
Take the most common case:
opening a checking account for a new
household. For customers who follow
through and make full use, this account
becomes central to their daily banking
lives. In turn, the primary checking
account is invaluable in providing the
information, access and bank rapport
that is crucial to high-value cross-sell.
Yet in U.S. banking today, typically
less than half of new checking accounts
With Onboarding, Cash Management Rules
are active after the first 90 days, the
typical time span for onboarding
activities. Most inactive accounts wind
up closed, with the result that closed
checking accounts are a major portion
of total account attrition in a bank.
The larger issue with onboarding
is that it needs to do a much better
job of fostering customer loyalty and
relationship development. The more
a bank can meet a customer’s daily
financial needs, the more loyal the
customer becomes and the higher the
odds for fuller “wallet penetration”
over the life of the relationship.
Instead of an initial burst of
“product cross-sell,” as often is the
case today, onboarding programs
should seek to establish the bank as
the customer’s primary cash management provider, in line with the needs of
each individual. This includes presenting the right family of products and
ensuring activation and full usage.
Critical Juncture
Onboarding has reached a critical
juncture as consumers shift more of
their banking activities from the traditional branch to alternative electronic
channels, primarily web and mobile.
The first time that a new customer
walks into a branch to open an initial
account may be the last time for a visit
to a lobby.
This increases the pressure to
optimize the dwindling amount of
Figure 1: Major Domains of Retail Customer Needs
Customer engagement with the bank determines the bank’s brand permissions for cross-selling and deepening
the relationship. The possibilities are quite different depending on the category of customer needs.
Daily Living
The future
Cash Management
• Checking accounts
• Savings / CDs
• Credit cards
• Debit cards
Investments
• 401k / IRA
• Brokerage / equities
• Planning
• Annuities
Cash management is typically the core of
the relationship expansion opportunity
Major Purchases
• Customers with an active everyday
banking relationship supported by an
active transaction account
• The most common emphasis at the
point of relationship inception, with the
broadest customer base overall
• Provides the greatest depth of customer
information and insight
• Provides the most regular and frequent
interactions and brand engagement,
even with a single-product relationship
based on a transaction account
• Highest overall profit potential
Purpose Credit
• Home mortgage
• Auto loans
• HH durable goods
• Personal
Risk Management
Insurance
• Term life
• Health
• Personal
• Liability
Types of products matter,
not just the total count
• Implies a different quality
of relationship (e.g.,
active card only vs. active
checking only)
• Different context and
starting point for cross-sell
(e.g., opening a savings
account vs. opening a
home equity line of credit)
• Potential huge differences
in value (e.g., credit card
vs. a term deposit)
Source: Novantas, Inc.
As seen in BAI Banking Strategies
November 2014
19
With Onboarding, Cash Management Rules
“A relationship expansion strategy cannot be guided simply on the basis of product count. It needs
to reflect how a customer engages with the bank, which in turn determines the bank’s brand
permissions for cross-selling and deepening that relationship.”
face time with new customers. It also
pressurizes follow-up onboarding
activities, which now must address the
broader experience of multi-channel
banking and all of its complexities.
In this increasingly delicate situation, a single goal often dominates
the bank response: sell whatever can
be sold. The sales urgency is driven
by longstanding research showing
that a big chunk of a customer’s total
product purchases from a particular
bank typically occur during the first
90 days of the new relationship.
But recent Novantas research suggests a different approach is needed.
First, the majority of sales to a new
retail banking customer typically are
either booked or instigated on day
one, right at the original point of sale.
A stream of offers during the 90-day
onboarding period often yields little
revenue and can become off-putting to
new customers, discouraging activation
and usage of their initial accounts.
Second, not all originations are
created equal. The best possible
start with new retail customers is to
provide the fullest possible range of
products within the defined space of
cash management, or offers that will
help them to manage their monthly
household finances and payments.
This point-of-sale (POS) “center of
gravity” should be supported by
product bundles and reflected in
performance metrics and incentives.
Third, the bulk of the onboarding
period should be devoted to capturing
“share of balance flows,” as reflected
in both the inflow of paychecks and
other financial resources and the outflow of cash and payments that keep
20
the household running. Encouraging
direct deposit and electronic bill pay is
a start, but ultimately it is about facilitating transactions and payments however each customer wants to do them.
Cross-Sell Foundation
The main thing is getting in touch
with the way that retail relationships
evolve. A relationship expansion
strategy cannot be guided simply on
the basis of product count. It needs
to reflect how a customer engages
with the bank, which in turn determines the bank’s brand permissions
for cross-selling and deepening that
relationship (Figure 1: Major Domains
of Retail Customer Needs).
In this sense, the benefits of the
primary cash management relationship cannot be overstated. It, more
than any other category of banking
products and services, gives the bank
permission to talk with customers about
their full range of financial needs. It
also provides incredible insight and
data for marketing and sales; reveals
the most about household financial
condition; and is interwoven in
consumers’ daily financial activity.
The resulting advantage shows
up in the formation of total consumer
balances (checking, savings and
certificates of deposit). Our research
indicates that the lion’s share of
retail funding comes from customers
with active checking accounts, with
only a trickle of balances associated
with inactive accounts. In one multibank study, the funding contribution
of active checking customers was
roughly 10 times that of inactive
accounts, as measured by total retail
balances per checking relationship.
Primary cash management
relationships also are the most profitable. Our research indicates that
when such relationships are cross-sold
into multiple needs categories over
the life of the customer involvement
with the bank, they can yield up
to 10 times the value of single-service relationships, or relationships
built upon non-primary accounts.
Strategically successful onboarding
sets the stage for such results.
Clearly, the value is not booked
during the initial onboarding period.
It shows up over time. In fact, the
right measure is not products sold
or balances transferred during the
first 90 days, but rather whether the
account is active with multiple transactions after just 60 days. Profitability
and deposit balances will follow.
The bottom line is that following
the enrollment of the new customer,
retail banks should be doing everything in their power during the
onboarding period to encourage the
cash management relationship, including account activation and usage and
the introduction of logically-related
products and services. This will lay
the best foundation for cross-sell over
the ensuing months and years.
Rick Spitler is Managing Director and
co-CEO and Sherief Meleis and Hank Israel
are Managing Directors at Novantas Inc., a
management consultancy based in New York
City. They can be reached at rspitler@
novantas.com, [email protected], and
[email protected], respectively.
Commercial Deposits and Liquidity Management:
Strategies for an Era of Change
BY MICHAEL RICE AND ANDREW FRISBIE
To preserve deposit momentum in a future season of rising rates, commercial banks will
need to refine products, pricing and sales force structure. Analytics will be key.
By any measure commercial deposit growth has been breathtaking in recent years, leaving many banks flush with near-term
commercial liquidity. Compared with a 3% historical average,
bank deposit balances from non-financial corporations grew
by 21% annually between 2008 and 2013, according to
Federal Reserve data.
But how much of this liquidity will remain to fund loan
growth when rates normalize and a fuller economic recovery
takes hold? The question is viewed with some degree of trepidation by seasoned commercial bankers, who recall funding
dislocations in prior rate cycles and wonder if the effects will
be magnified this time around.
One concern revolves around corporate treasurers. After
spending more than a few post-recession years stockpiling
cash in commercial bank accounts, treasurers are seeing more
pressures to withdraw resources to fund corporate expansion.
They also will be alert to opportunities to migrate funds to
higher-yielding accounts, for example, possibly awakening the
interest-bearing business checking account, which has been
mostly dormant following its emergence after the repeal of
Regulation Q.
Another concern is new regulation. Under the finalized
Liquidity Coverage Ratio (LCR) rules, important categories of
commercial deposits are not viewed as reliable long-term funding from a regulatory standpoint, forcing the biggest banks
to hold highly liquid (and lower-yielding) securities investments
as an offset. This lowers the usefulness of commercial deposits
and limits what banks can offer to attract and retain them, disrupting the treasury services business model.
The situation presents a clear call to action on go-to-market strategy for commercial deposits. Going into 2015, many
commercial banks will need review and improvement in two
major areas:
Products and pricing. Products will need be reconsidered
from the standpoint of how resulting balances will be interpreted and treated under LCR. Also there is much work to be
done in refining deposit pricing strategy, both in setting publicized rates and in client negotiations.
Sales force structure. Commercial banking has enjoyed
a growth surge in recent years. But to sustain the pace in a
changing environment, many institutions must address longstanding issues with loose sales force structures that cause
opportunity to be lost.
A foundational requirement for these two initiatives is
improved analytics. Commercial bankers need precise information to aid strategic and tactical decisions in areas such as
portfolio management; product and negotiated pricing; modeling of client potential; and reconfiguring the sales force in
line with regional market and customer segment opportunity
(Sidebar: Aligning Analytics with Business Objectives).
Products and Pricing
Though product differentiation has been muted during the long
period of flat interest rates, the issue will reemerge as the rate
“accordion” expands. Products must be realigned to offer customers clear choices while upholding bank profitability.
The first step is to consider the product continuum in light of
the bank’s target customer segments. Each product along the
liquidity management and deposit continuum must be evaluated
across four factors: rate, return, liquidity and convenience.
Next, the bank should review current offerings in light
of recent regulatory changes and the likely coming environment of rising rates. Banks with more than $50 billion
in assets are subject to LCR restrictions that limit the returns
from many deposit categories. Many are already exploring
ways to make their products “LCR-friendly,” for example, by
emphasizing notice accounts, or by documenting the linkage
of various separate accounts to a stable core customer relationship (to improve the standing of the separate accounts
under regulatory rules).
Finally, the bank should review its pricing approach for
margin (interest rate and earned credit rate (ECR)) and fees.
November 2014
21
Commercial Deposits and Liquidity Management: Strategies for an Era of Change
Pricing practices among commercial bankers have significant
room for improvement, with many leading techniques not yet
in broad use.
With technique, there is substantial ground to be gained with
segment-based pricing; applications based on price elasticity of
customer demand; analysis and control of pricing dispersion in
the field; and systematic price optimization based on a blend of
performance considerations. Opportunities with pricing practices
include the introduction of standardized processes, negotiated
pricing reviews and clear governance structures.
Improvement in negotiated pricing is a particular priority, given that most pricing with larger deposit relationships
is determined via banker negotiations with the client. In these
situations often the client parlays with several competing banks
and has a negotiating advantage, and meanwhile individual relationship managers have their own practices and bargaining considerations — all adding up to significant pricing
dispersion in the field. Many banks are in need of structured
negotiating processes supported by robust deal information
repositories (i.e., won/lost, terms, client characteristics, relationship context) and clear guidelines.
Simply by enhancing their approach to commercial deposit
pricing, some major banks in the United States, Canada and
the United Kingdom have achieved margin improvements of 5
to 15 basis points across their portfolios.
Sales Force Structure and Deployment
Despite most banks’ renewed focus on raising commercial
deposits, the roles and responsibilities of those leading the
charge — relationship managers, treasury management specialists and portfolio managers — are typically are not well-defined, often leaving teammates lobbying for ad hoc support.
As generalists, for example, relationship managers must
be able to rely on specialists to assist with key elements of
deposit and treasury management relationships (particularly as
cash management offerings become more complicated), but
they often cannot tap this expertise when needed. Elsewhere,
portfolio managers often have the best view of latent deposit
opportunities among current customers, yet they are rarely
enlisted in identifying and tapping opportunities.
Such disconnects will have increasing consequence in the
coming era of rising rates. In addressing the situation there
are major categories of decisions, including: 1) sales structure
(specializations, roles, responsibilities); 2) deployment (local
staff count, configuration and book of business); and 3) performance metrics, goals and incentives.
In fairness, there is no “one right way” to treat these issues,
and seasoned professionals will have strong viewpoints and
legitimate differences of opinion. Along with sensitivity in
exploring the options, the bank will need a set of solid analytics to provide objective context. Analytics can support decisions in several areas:
Structure. In a comprehensive review the commercial bank
takes a fresh look at the respective roles of the relationship
managers, treasury management specialist and portfolio managers in identifying and closing deposit business. This includes
Aligning Analytics with Business Objectives
In a competitive era that increasingly requires precision decision-making, analytics are destined to play a growing role in commercial banking, with applications across the performance spectrum. Progressive banks are capturing business benefit and avoiding
unfruitful investment by ensuring that their analytic applications are:
Inquisitive. Analytics can pinpoint key business drivers and
performance issues, including targeting for individual customers
and segments; appropriate product pricing and fee structures; and
improvements in sales force structure and deployment.
Descriptive. Here the analytic focus is on sophisticated pattern
recognition and accessible interpretation. Line-of-business leaders,
for example, want to be able to directly understand subtle LOB
performance patterns without having to rely on the Ph.D. quants
to translate the results.
Predictive. Analytics should do more than describe past phenomena; they must provide insight into the likely outcomes of a
business decision — for example, the likely changes in spread and
22
volume from a potential product re-pricing move.
Prescriptive. Analytics should point the way toward specific
strategies and tactics that will permit the team to capitalize on the
revealed opportunity.
In putting all of this to work in commercial deposit strategy,
there are three main focal points, including diagnosing and anticipating balance flows; opportunity modeling for the customer
portfolio; and opportunity modeling across regional markets and
industry sectors.
1) Balance flows. What are the drivers of balance changes within
the commercial deposit book? Answering this important question
requires more analytical granularity than period-on-period changes.
Instead a deeper dive into portfolio dynamics is needed.
For example, is balance growth primarily being driven by new
customer acquisition or deepening of current relationships? In
instances of balance runoff, are customers simply using withdrawn
funds to finance growth, or switching select accounts to competi-
Commercial Deposits and Liquidity Management: Strategies for an Era of Change
considering whether the sales force should align with an industry segmentation (e.g., specialists in manufacturing, health
care, agriculture), or regional markets and revenue tiers. Also
there are questions on coverage cut-points relative to revenue
tier or client complexity.
Sales force specialization can help. For example, “deposit-only” relationship managers can be a powerful force in
broadening the bank’s presence in deposit-rich segments (but
care must be taken to avoid sending a message that only these
specialists are responsible for driving the unit’s deposit growth).
Setting this in motion starts with identifying current staffers
who excel in deposit-gathering, for “best practice” learning
related to their roles and responsibilities. The bank also must
ensure that assigned positions are aligned with franchise
opportunity (with particular regard to revenue tiers and industry segments).
Deployment. Here the bank is working to optimize the
placement of generalists and specialists in the right markets.
Considerations include:
• Identifying the right number of specialists for each market.
• Ensuring that goals and coverage assignments are aligned
with market opportunity. Roles and responsibilities
play into this as well. Relationship managers expected
to emphasize closing deposit business will have
different goals from those functioning more as business
development officers.
• Identifying possibilities for market- and sector-specific
specialists who may not be deployed elsewhere in the
franchise. The bank may assign a variety of industry
sector specialists in key metropolitan statistical areas, for
instance, but find that smaller peripheral markets do not
warrant that kind of commitment.
Metrics, goals and rewards. By understanding the actual
share of client deposits held by the bank and the penetration
of a given RM team, a bank can avoid the common pitfall
of under-goaling RMs in strong markets while under-rewarding
bankers who may be beating the norm in weaker markets. Too
often, RM goals are set without regard to the opportunity inherent in their footprint and area of specialization.
tors in order to capture higher rates, or are they actually switching
their cash management relationships to competitors?
2) Customer opportunity. For the many institutions still
evolving from a credit-centric culture, relationship managers and
executive leaders typically underestimate the potential to capture
additional deposit balances that current customers hold with other
banks. However, the wealth of portfolio management and transaction information about current customers can reveal deposit opportunities with specificity.
In one instance, a superregional bank found that it had been
consistently underestimating client-level deposit potential by 30%,
leaving opportunities unpursued. Most banks find that plugging
such gaps to gain share with established customers is the first step
to more robust deposit performance. Opportunities to expand
“share of wallet” are enhanced by the knowledge, rapport and leverage that commercial banks enjoy with core deposit relationships.
3) Market potential. Typically we find that the commercial
bank is handicapped in decision-making by a lack of specific information on market opportunity, including geographies, prospect
revenue tiers and industry sectors.
Assessments of revenue potential can be aided by segmentation
techniques such as look-a-like analysis, which assesses the experience with current customers of a certain profile and extrapolates
the findings to prospects having similar profiles. Revenue potential
models can build on these insights by leveraging third-party data
— an important consideration when reviewing segments that are
remote to the bank’s experience.
These exercises routinely reveal “surprise” pockets of deposit
under-penetration across the commercial banking franchise. A
consistent finding among credit-oriented commercial units is
that they are overweight in credit-heavy customer segments and
under-penetrated in other customer segments that are deposit-rich.
Setting Priorities
Through the analytical exploration of these questions, ultimately
the pieces can be brought together in a segmentation scheme
that helps the bank to identify and address priority issues, both
in areas of under-performance and those having the greatest
potential returns. Commercial deposit strategy then is brought
to life through a refined focus on geographies, target industries
and client revenue tiers, using the levers of product, pricing and
sales force design and deployment.
Michael Rice is a Managing Director in the Chicago off ice and
Andrew Frisbie is a Managing Director in the New York off ice of
Novantas Inc., a management consultancy. They can be reached at
[email protected] and [email protected], respectively.
— Michael Rice and Andrew Frisbie
November 2014
23
CCAR PPNR Modeling
BY ANDREW FRISBIE AND Jonathan WEST
Improved modeling for pre-provision net revenue requires strengthening the project
framework, working to overcome data sterility and testing alternative approaches.
In past cycles of the Federal Reserve’s Comprehensive Capital
Analysis and Review (CCAR), banks pushed to improve their
modeling for credit losses as a key input for capital management. More recently the Fed is pressuring banks to advance
their modeling for pre-provision net revenue (PPNR). Both in
public pronouncements and in private memoranda to many
CCAR banks, the Fed is expecting progress in two areas:
First, PPNR models are now expected to reach a level of
rigor and consistency in statistical approach commensurate
with previous advances in loss modeling. Second, banks are
being asked to ensure that their advancements in PPNR modeling bring capital management closer to business forecasting
and decision-making.
However, banks and their regulators find themselves in a
paradox. Even as banks improve their competency in PPNR
modeling, our ongoing review of prevailing practices among
CCAR banks indicates that many institutions are shifting
toward an increasingly similar and rigid approach to satisfy
important statistical tests. This exposes banks and the industry
to two implementation risks.
One is business line disconnect. In the act of assuring
adherence to regulatory statistical requirements, models are
typically bleached of management-related variables, causing the business units to fall back on time-worn approaches
(which are lacking in statistical sophistication) to make forecasts and business decisions. This outcome is at odds with the
Fed’s desire to integrate capital management decisions with
business strategy and execution.
Meanwhile, CCAR banks are tending to converge on one
specific approach to PPNR modeling. This creates systemic
risk that the industry collectively might make material misestimates of PPNR under different scenarios.
To meet these challenges and expedite their PPNR projects for full benefit, progressive banks are focusing on three
24
priorities. One is developing the right modeling project framework, with emphasis on detailed preparation and a strong
working team. Another is overcoming data sterility by incorporating management actions into predictive models. Third is
embracing a challenger mindset by testing proposed models
against alternative approaches — essential to avoid a singular reliance on a “standard industry approach.” Banks at all
stages of PPNR development can use these keys to improve
the robustness of their models and enhance their ability to
drive business decision-making.
Modeling Framework
The time between receiving regulator feedback and submitting
models for internal validation is short, even considering the
90-day extension of the submission deadline for next year’s
plan. Most banks are compelled to cram their modeling development into a tight window — often 90 days or less.
Given this quick pace, one of the largest risks to a successful development cycle is identifying a critical gap late, without
enough remaining time to thoughtfully redevelop a model.
Banks can avoid this trap by developing a strong working
team early in the process — before modeling begins.
This team includes model developers, business managers
and model validators. Supported by the right governance, a
well-prepared development team can:
Eliminate re-work. CCAR models attempt a delicate balance between statistical reasonableness and business intuition, using a relatively limited set of potential drivers. When
banks discover problems late in the process, they do not get
“extra time” to correct troublesome issues (e.g., finding that
the underlying data of macroeconomic variables are wrong,
or that the intended uses of the model has changed). Instead
they must settle for making less progress than what was committed to their Board and to their regulators.
CCAR PPNR Modeling
Set validation expectations. To make the validation process more productive within their required independent
framework, model developers need to stay abreast of any
“must do” items, including required advances needed to satisfy Fed Memorandums Requiring Attention (MRAs), or other,
more stringent orders.
When brought into the process early, business partners
often are more cognizant of the statistical requirements and
corresponding limitations of the models. Likewise through
early involvement, model validators can provide their general
parameters and suggest potential problem areas that the developers should rectify before they go through the labor-intensive
phase of documenting models for official review.
The best PPNR development frameworks are clarified and
agreed upon before model development begins. This is critical, as timelines suffer when goalposts are moved. The working group must:
Define and source the modeling dataset. Data must be
well-defined, extensive, and assembled at the best available
level of granularity and frequency. Often this requires judgment calls between models built on shorter, more granular
datasets vs. longer-term and less segmented data.
Agree on what to model. Model development primarily
will be guided by business needs and data availability, but
PPNR Modeling: The Basics
What is PPNR?
Pre-provision net revenue (PPNR) measures net revenue
from spreads and non-trading fees. It is similar to operating
revenue but excludes items covered elsewhere in the Fed’s
Comprehensive Capital Analysis and Review (CCAR). These
exclusions include credit losses; markets and trading revenue
(typically material for only a handful of banks); and losses stemming from operational risk (for instance, legal settlements).
Why has PPNR modeling become a top priority within CCAR?
The Fed’s focus on PPNR represents a logical progression in its
campaign to ensure that major banks have a complete understanding of their capital positions, both in base and stressed scenarios.
In the early years of stress testing, the top priority was ensuring that banks understood the potential impact of credit losses on
capital. But as banks improved their credit modeling competency,
regulators found that the variability revealed by PPNR estimation
(balances, related spreads and fee income) exceeded variations in
credit losses. PPNR was the logical candidate for Fed emphasis.
Why is PPNR modeling so challenging?
At first blush, PPNR modeling appears similar to recurring exercises for line of business budgeting and forecasting. But building
models to CCAR standards introduces many complexities relative to traditional forecasting approaches, often leaving business
lines alienated; modeling teams exasperated; and regulators and
model validators dissatisfied.
Data requirements. PPNR modeling often requires much
more data than banks typically use for planning purposes, both
time span and breadth, including:
• Ten years of monthly balance and fee data (or at least enough
to capture a full rate cycle).
Portfolio-level balance histories at the minimum; ideally such
information at the account/customer level.
• Records of management actions (e.g., pricing, marketing, distribution changes) for this long historic interval.
• Treatment for mergers and acquisitions, and other disruptive events.
Modeling requirements. Unlike customary line-of-business
planning exercises, PPNR models must be able to withstand
model validation and regulatory scrutiny, pressurizing the model
development process.
PPNR models are typically built within a framework of
time-series modeling, for example, which is not frequently used
elsewhere in the bank. This often leaves the modeling and validation teams treading on unfamiliar ground.
Another issue is the time horizon and types of variables
included. PPNR models typically are expected to explain longterm trends, using both macroeconomic and management variables. By contrast, traditional bank internal forecasting considers
a shorter time horizon and frequently includes only management
levers. This can lead to situations where model developers and
LOB executives wind up “talking past each other” in hypothesis
development and driver review.
Taken together, these development challenges often skew the
resulting PPNR models in one of two directions: Either they satisfy statistical “purity” while becoming divorced from the expectations of the business; or they satisfy business intuition but fail
critical statistical tests. Both pitfalls can result in regulatory sanction and create risks in bank capital management.
•
—Andrew Frisbie and Jonathan West
November 2014
25
CCAR PPNR Modeling
decisions should be made up-front on whether models will be
developed at the general product level or the LOB-specific
product level (e.g., consumer DDA); and whether the portfolio
or cohort components will be tested.
Finalize the statistical techniques and acceptance criteria.
There are some non-negotiable statistical tests every model
must pass. The importance, desired structure and acceptance
criteria of many other tests — notably out-of-sample testing and
serial correlation checks — can vary from bank to bank. Also
as addressed more fully below, testing alternative modeling
approaches with potentially different statistical requirements
is an important cross-validation exercise to be encouraged.
Incorporate business feedback early and often. A critical
requirement of CCAR models is that they reflect business intuition and are “bought in” by business managers. Best-practice
teams solicit hypotheses from business managers before
model development begins, and they review results iteratively
as models are finalized.
Overcoming Data Sterility
Most PPNR teams have realized that the uniqueness of their
bank’s strategy and go-to-market approach limits the ability to
model a powerful statistical relationship between balance/fee
movements and purely macroeconomic factors. For this reason, specific management actions have become a vital input
into the more predictive models. Key examples include:
Product rate relative to the competition. For rate-based
products, this measure tends to be one of the most influential
in improving a model’s predictive power.
Distribution coverage. Examples include the branch network, commercial relationship managers and sales staffing.
Banks that make major changes in distribution coverage often
experience a multi-year lagged influence on overall balance
growth. No other measure directly captures this dynamic.
Product introductions. The launch of a product with different or innovative features often introduces a bank to new market segments which may have been historically underserved,
resulting in aggressive short-term growth.
By accounting for such factors, banks can materially
improve the predictive power of their models. While broadbrush influences on a product portfolio may track with macroeconomic factors, intra-year or intra-quarter movements
often are more directly influenced by the specific levers
pulled by management.
Once quantified, these levers can be presented as clearly-defined management adjustments to the macroeconomic-based forecast in the final CCAR submission. Otherwise
banks must rely on “finger-in-the-wind” estimation when
proposing adjustments to strict model outputs. These purely
26
qualitative adjustments are far less defensible and more
likely to invite regulatory and validation scrutiny, compared
with documented management actions with proven measurable effects.
Challenger Mindset
Most banks use some level of challenger models and analytics for a “sense check” of candidate model results, compared with industry deposit changes in stressed environments.
Robust challenger processes do not treat this as a pro forma
exercise, but rather as a mindset.
The goal is to insulate the bank from potential downsides, either stemming from deficiencies in an individual
model, or from a systemic deficiency stemming from industry
over-reliance on one specific model theory, functional form
or set of statistical constraints. A stronger challenger discipline allows banks to:
• Quantify the impact of alternative models for a given
product. One example is evaluating the effect of
certain substitute macroeconomic variables. Another is
comparing models that are dominated by macroeconomic
variables vs. alternatives that document the influence of
management actions.
• Evaluate trade-offs, including those inherent in different
modeling methods. In the statistical realm there are
pivotal decisions to be made about the type of regression
technique to be used (for instance, ordinary least squares
(OLS) vs. partial least squares (PLS)). Also there are
tradeoffs in applying differing standards of statistical
purity vs. business intuition.
• Leverage alternative analyses to enrich the narrative; the
management overlays; and the plans for ongoing progress
in PPNR modeling.
To establish the right fact base, each candidate model
should have alternatives that test competing and related macroeconomic variables, enabling sensitivity analysis. Banks
can also consider applying alternative analytic approaches
(e.g., portfolio modeling, cohort-vintage modeling, industry
and market share modeling) across the overall set of models,
permitting tighter side-by-side comparisons that help to identify consistencies and deviations among significant variables
and results.
Andrew Frisbie is a Managing Director and Jonathan West is a
Principal at Novantas Inc., a management consultancy based in
New York City. They can be reached at [email protected] and
[email protected], respectively.
Liquidity Coverage Ratio:
More Challenges Ahead
BY PETER GILCHRIST AND STEVE TURNER
New regulatory liquidity standards will force significant changes in how banks manage
their balance sheets, impacting both the treasury group and the business lines.
With the finalization of new regulatory rules on the liquidity coverage ratio (LCR), large banks for the first time will
be required to operate within defined liquidity standards, in
addition to meeting tougher regulatory capital requirements.
This will force significant changes in how banks manage their
balance sheets, impacting both the treasury group and the
business lines. Leading banks are preparing now to meet
these challenges.
There is a temptation to relax now that treasury groups
have calculated the LCR position for their respective banks
and established corporate strategies to ensure compliance.
For many banks, there are still significant build requirements
for information systems (e.g., to support daily reporting),
but treasurers are calm, believing they can meet further LCR
requirements within the mandated timeline.
It is an eerie tranquility, for two reasons. First, the banking
industry is more liquid now than at any time in the last 50
years — a result of de-leveraging during the crisis and tepid
post-crisis loan growth. Second, the Fed’s Quantitative Easing
(QE) has flooded the banking system with approximately $4
trillion in deposits.
These forgiving circumstances for bank liquidity will begin
to reverse with QE ended, loan growth picking up and accelerating economic activity. In a not-so-distant scenario, meeting LCR requirements could become far more difficult than
what bankers are experiencing today.
The upshot is that many banks risk being caught
under-prepared to cope with the strategic balance sheet
implications of LCR. With commercial and retail deposits,
for example, LCR fundamentally changes the value of various products and accounts — with major implications for
Treasury and the business lines. Banks are just starting to
address these differences.
Savvier banks are already making strategic choices about
how deposit businesses will need to evolve to maintain profitability in the new landscape. They are adjusting the design
and pricing of deposit products to ensure offerings meet customer needs while providing the requisite profitability and
liquidity for the bank. But before changes are even considered, most banks have work to do in building foundational
data and advanced performance metrics to evaluate their
strategic choices.
Major Changes; Major Questions
LCR rules are specific on the calculation of liquidity sources
and uses, which affects the valuation of balance sheet items
and, in turn, the commercial and retail business lines. On
the asset side, acceptable sources of liquidity have been narrowed and their contribution tiered: government-backed securities approach dollar-for-dollar regulatory liquidity value, but
other types of investment securities receive large haircuts and
are of more limited use.
On the liability side, certain types of deposits receive high
liquidity value under LCR rules while others have no value at
November 2014
27
Liquidity Coverage Ratio: More Challenges Ahead
all, significantly affecting their absolute and relative worth.
For example, insured retail deposits in transaction accounts
are the bulwarks of LCR liquidity strength, with almost all
of these balances available for funding loans. By contrast,
non-operational commercial deposits and corporate/interbank deposits will receive a much lower liquidity value, limiting the amount of these deposits available for funding loans.
The situation has created a series of important questions
for the commercial banking operation; the retail banking
operation; and the treasury group.
The commercial business is asking:
• How can we reformulate treasury services to meet
customer needs profitably, given that the liquidity
contribution of treasury services deposits has been cut
by at least 25%?
• What is the role for non-operational commercial deposits,
given their much lower ability to fund loans under LCR?
What changes should be made in their structure and price?
The retail business is asking:
• What is the ceiling on the value of insured retail deposits?
How should we be positioned for a potential bidding war
that LCR could touch off for these deposits?
• What role should uninsured certificates of deposits play?
Should a term CD with severe early withdrawal penalties
be part of the bank’s deposit funding strategy?
Treasury is asking:
• What information will be needed to optimize funding?
“Non-operational commercial deposits and
corporate/interbank deposits will receive a
much lower liquidity value under LCR, limiting the amount of these deposits available
for funding loans.”
• Should pricing decisions be based on marginal or average
liquidity impact?
• How should the costs of a liquidity buffer be reflected in
funds transfer pricing?
These questions must be addressed to make sound strategic choices. The commercial business will want to refine the
treasury services product offering (and associated pricing) so
that it continues to be profitable. The retail business will want
to consider the lengths to which it will seek to retain highly
valued deposits, even at the expense of rates, fee waivers
or other profitability compromises. Meanwhile Treasury will
need to consider multiple LCR-informed funding scenarios,
depending on business line decisions and unfolding market
influences.
Analytic Foundations
For each strategic choice, executives must evaluate a variety
of unique-to-bank factors such as retail strength; commitment
Will LCR Affect Smaller Banks?
LCR rules apply to banks with more than $50 billion in assets.
Smaller banks, while immune from LCR rules for now, suspect
increased liquidity regulation may be coming their way soon. This
is likely to start through the supervisory process, with examiners
applying LCR calculations to these banks and continuing with
formal liquidity rules for banks above $10 billion in assets. Many
of these banks are already informally calculating their LCR positions and taking actions to improve their liquidity profile in situations where initial test results varied significantly from official
compliance levels.
In any case, LCR rules will affect the broader deposits market,
forcing small banks to play in a different landscape:
Increased competition for highly-valued retail deposits. LCR rules
provide favorable treatment for retail deposits, especially insured
retail deposits. Industry insiders expect increased competition for
these deposits; through more aggressive pricing; product, service
28
and distribution enhancements; or both.
Decreased competition for non-operating commercial deposits.
LCR rules provide less favorable treatment for commercial deposits, especially those commercial deposits classified as non-operating. To the extent that these cannot be reclassified, industry insiders expect structural changes in the competition for commercial
deposits to structurally change.
Innovation in LCR-friendly products. New deposit products
with features that improve LCR treatment are being brought to
market. This is already evident with 31-day notice deposit accounts.
Increased usage of Federal Home Loan Bank funding.
Borrowing capacity at the FHLBanks has no LCR value, while
long-term advances are very beneficial to LCR. This will make
advance rates an important reference rate for small banks.
— Peter Gilchrist and Steve Turner
Liquidity Coverage Ratio: More Challenges Ahead
“Some banks expect plentiful liquidity to persist, supporting ongoing balance sheet flexibility and limiting the need for detailed LCR planning. But they are at risk of being caught flat-footed. Tomorrow’s
winners are preparing now for a changed liquidity environment.”
to commercial treasury services; the outlook for loan origination; and access to capital markets. Intuition and back-ofthe-envelope analytics will be insufficient in a world with so
many moving parts. At a minimum, LCR-related decisions
will require strengthened foundational data and performance metrics.
Foundational data. To formulate the best treatment for
deposits, the business lines and treasury group will require
new levels of detail on customers, account types and account
usage. The lines of business then need to understand how
differences along these dimensions will affect the value of
deposits.
This speaks to the need for an integrated deposit analytic
ecosystem. For the first time there are hard dollar differences
in the value of different deposits, giving treasury, commercial
and retail a keen interest in “single source of truth” data.
Banks that make this foundational information consistent
and available to all constituencies will be better prepared to
attract and protect the highest-value customer deposits.
Performance metrics. Most banks already are incorporating regulatory liquidity calculations into FTP, but there still
are many questions to be sorted out. For example, there are
a range of practices for valuing liquidity; translating liquidity
costs into FTP; and determining how to charge for the liquidity buffer. Also there are differences in bank situations that
lead to different liquidity valuations. All of these points must
be considered when designing FTP methodologies.
Some banks look to apply an LCR tweak to FTP and call
it a day. This will fail to meet the mark, as envisioned tweaks
rarely allow FTP to reflect the full dynamics of liquidity cost
and value. For example, most time-worn performance metrics
value insured and uninsured deposits the same; ignore regulatory factors in decay rate assumptions; and derive volatility
estimations (betas) from pre-crisis events that occurred in a
more stable climate.
Additionally, many banks are still relying on performance metrics that are unequipped to determine how liquidity values will change when the institution or the industry
shifts from excess liquidity to liquidity needy. There is clearly
a lot to do. This work needs to be agreed upon and implemented in advance of making strategic decisions on product
design and pricing.
Executive Agenda
LCR rules are changing balance sheet management. These
new rules, combined with an increased appreciation of
liquidity value since the crisis, are causing banks to revalue
deposits and adjust deposit strategies, product design, and
pricing. Deposits with the highest regulatory value will be
heavily fought over. Products must be redesigned with terms
friendly to LCR treatment. Pricing will incorporate the cost and
value of liquidity.
All this leaves banks with a succinct list of tasks:
1. Fix foundational deposit data. As discussed elsewhere in
this issue (“Integrating the Deposit Analytic Ecosystem”),
banks need to build a “single source of truth” for deposit
data so that analyses for the treasury group and business
lines are built on the same underlying information.
2. Refine FTP to incorporate LCR treatments. Through
its outflow assumptions, LCR introduces a regulatory
viewpoint that establishes universal deposit decay rates.
FTP should incorporate both the universal LCR decay rates
and internal analytically-based decay rates.
3. Adjust product design and pricing. Once the right metrics
are built on a solid data foundation, the business lines
and the treasury group can make the critical decisions on
adjusting product design and pricing.
4. Enhance treasury funding strategies. The effects of LCR
on bank funding instruments will make it more difficult
to identify optimal funding strategies. Treasury will need
to monitor balance sheet dynamics and create scenariospecific funding strategies.
Some banks expect plentiful liquidity to persist, supporting
ongoing balance sheet flexibility and limiting the need for
detailed LCR planning. But they are at risk of being caught
flat-footed. Tomorrow’s winners are preparing now for a
changed liquidity environment.
Peter Gilchrist and Steve Turner are Managing Directors at
Novantas Inc., a management consultancy based in New York City.
They can be reached at [email protected] and sturner@
novantas.com, respectively.
November 2014
29
COMMENTARY
Relationship Pricing: A Pragmatic Approach
Executives now must think more seriously about how to manage and price relationships.
Much depends on an understanding of the customer journey and lifetime potential.
BY SHERIEF MELEIS AND ADAM STOCKTON
C
ustomer relationship development is acquiring a new
priority and urgency in retail
banking. The reasons are threefold:
First, the volume of accounts up for
grabs has halved from historical norms,
and it could go even lower (note
that in consolidated banking markets
such as Australia and Canada, the
proportion of new accounts in motion
is a fifth that of the United States).
Second, the value of relationship
deposits has gone up dramatically from
a regulatory perspective, fueling the
urgency to consolidate as much of a
customer’s “deposit wallet” as possible.
Finally, quarterly profit pressures
inevitably compel the bank to emphasize cross-selling loans to current customers. Success can boost the lifetime
value of a customer relationship by as
much as 300%, making loan cross-sell
one of the most lucrative and available sources of additional revenues.
Given these and other factors,
executives now must think more seriously about how to manage and price
relationships. Here again, consolidated markets with little new-to-bank
customer potential (e.g., Australia
and Canada) are ahead of most
U.S. institutions. But the U.S. revenue
management agenda will increasingly focus on relationships as well.
An important variable in relationship management is relationship
pricing. But despite the growing
importance of relationships, many
bankers have not thoroughly reviewed
relationship pricing, believing they
30
have already mastered the concept.
The most common approach
is to give discounts as incentives
for incremental product sales. For
example, a bank might offer a 25
basis-point reduction on a mortgage
or loan to “relationship” customers, under the presumption that the
discount will incent the customer
to open the additional account.
A second, lesser-used approach
is to offer a favorably-priced bundle of products (especially at the
inception of a new relationship). This
signals the bank’s desire to serve the
customer more fully and can be a
helpful tactic in some circumstances.
Though widely practiced, these
two approaches are often applied
naively and ignore some important
challenges. First, product managers
are loath to give up margin for a
customer-level relationship. Second,
relationship customers are typically
the most profitable and least driven by
price, making “relationship discounts”
something of a conundrum. Finally
and perhaps most important, relationship pricing offers tend to ignore
the way customers establish durable,
valuable relationships, i.e., over time
as they gain confidence and trust in
the bank and its brand promise.
The upshot is that many retail banks
may actually be setting themselves
back with today’s relationship pricing
approaches. To fundamentally succeed
in the relationship game, many will
need to re-orient their programs.
Depending upon the bank’s
circumstances, it will need to clarify
its understanding about the customer
journey and lifetime relationship
value of different paths. It will also
potentially need to re-examine how
products fit together and, in particular, how to use relationship pricing to
support customer journey objectives.
First Things First
Relationship pricing is a customer-centric concept and needs to be managed
within the context of the customer journey — the progression of the customer’s involvement and rapport with the
bank over the life of the relationship.
Relationships are not established
all at once, presenting a very different set of pricing considerations over
time. Especially in the early going,
the overriding priority is setting a
durable relationship foundation,
namely fulfilling the customer’s core
cash management needs — checking, savings and revolving credit.
By capturing the customer’s core
cash management relationship, banks
gain a brand advantage in selling
add-on products. Through subsequent
high-value cross-sales, banks can
monetize early efforts to establish
the cash management relationship.
The ideal strategy is not to use
price at all. Better to have an ongoing discussion with customers about
their needs and sell at list price
the products that meet those needs
explicitly. Remember, relationship
customers are the least price-sensitive.
However, should a bank chose
Relationship Pricing: A Pragmatic Approach
to use price, it should do so with an
“exchange” concept in mind, or an
explicit deal for the mutual benefit of
the bank and the customer (i.e., by
taking action on a specific offer now,
the customer can gain more favorable
terms). This form of relationship pricing
assumes that an incentive is needed to
get more of a customer’s business and
that the incremental business will pay
back the give-up in price. The bank
will want to minimize “false positives”
— instances where a price incentive
is offered but not actually needed.
Bundling can also make sense,
but typically only within the context
of establishing the core cash management relationship. Event-based
lending for cars, houses, education,
etc. is best cross-sold to customers
as needed, and not bundled with
products at the onset of a relationship.
Thus banks must have a notion of
how a relationship develops and a
corresponding customer-derived logic
for when and where to apply pricing.
Inflection Points
In the progression of the customer relationship with the bank, there are major
inflection points where relationship
pricing might be applied (Figure 1: Key
Progressions in the Customer Journey).
In each case the economics should govern. The transitions are as follows:
Progression from an initial checking
account to a complete set of cash management products and services. Most
people initially approach a bank for a
checking account. Expanding to a core
cash management relationship (with
associated savings and revolving credit
products) is best accomplished through
good needs-based selling skills.
That said, at the onset of a
relationship there is a role for a
price-incented “bundle” of cash
management products, such that
with activation and engagement, the
bank can make a relationship profit.
The “bundle” signals the bank’s
interest in a broad relationship and
a willingness to trade off rates/fees
(mostly fees) in return for loyalty.
Progression from enrollment in
cash management offerings to activation and usage. Typically there is
a 30– to 90–day window to convince customers to actively use their
newly-acquired cash management
services with the bank, essential in
allowing the bank to become the
primary cash management provider.
This could simply entail explaining
the products, but it also might entail
using price incentives to change behavior. Examples include some type of
bonus for account usage; a rate advantage for a particular behavior (balance
offers with credit cards); or added
loyalty points and/or recognition.
Progression from engaged cash
management relationship to an
expanded “share of wallet.” Here,
the objective is to consolidate the
deposit and revolving credit wallet
of the customer. An exchange-based
pricing logic (take the following
actions and receive the following
Figure 1: Key Progressions in the Customer Journey
In the progression of the customer relationship with the bank, there are major inflection points where relationship pricing might be applicable
Transition 1:
Expand from
checking to all
cash mgmt
products
New
checking
account
Transition 2:
Engage the
customer &
incent active
usage
Complete
cash mgmt
products
Transition 3:
Consolidate
the deposit and
revolving credit
wallets
Activation
& usage of
services
Transition 4:
Cross Sell
High-value
event-based
(episodic)
Cash mgmt
wallet
consolidation
Loan & large
deposit
cross-sell
Selective Opportunity:
Migrate event-based customers into
core cash management relationships
Source: Novantas, Inc.
November 2014
31
Relationship Pricing: A Pragmatic Approach
pricing benefits) clearly could obtain.
Before reaching for the price lever,
however, functional or loyalty benefits
of the products should be promoted.
Progression from an in-depth
relationship to a high-value, eventbased cross-sell. The objective is the
cross-sell of loan or liability products
that typically are “event” based, such
as the financing of a car, house, or
home improvement, or the deposit
of a tax refund or bonus. These
products can triple the current and
future profitability of a relationship.
The pricing challenge at this
stage is that the event is driving the
purchase, making it hard to tell when
incentives are really needed. Any
kind of routinely offered, product
vs. customer-based discount runs
the age-old risk of offering concessions where not needed (false positives), which can be quite costly.
In these cases, given the strong
brand loyalty built via the in-depth
cash management relationship, the
bank’s best opportunity is to stay
poised to offer a relevant and competitive product as the customer
begins to understand the need. The
bank typically does not have to offer
aggressive incentives in such episodic demand circumstances — the
customer is driving the purchase
process based on need and is primarily focused on the product.
If, finally, an “incentive” discount
appears helpful, it is best done on
a customer-by-customer basis, as
opposed to an aggressive, “relationship-oriented” and product-based
pricing promotion intended to generate demand. Overall, time is better
spent on predicting customer needs
and fulfilling them conveniently.
Key Questions
Applied surgically, relationship
pricing can indeed be used to a
bank’s advantage. It should not be the
province of the product management
organization, but rather a tool in the
ongoing customer relationship management strategy. It can be used in
either bundled or incentive form. But
again, it all depends on the particular
relationship objective.
Relationship pricing should avoid
the ill-conceived notion that if you have
a relationship, you get a discount on
other products. Rather it should always
be used in an explicit “exchange”
of current or future value with the
customer. Relationship pricing should
not be used to drive demand but to
incent consolidation of the wallet.
With these points in mind, executives should be asking the following questions before approving a
relationship pricing agenda:
• Does the bank have the right
customer journey objectives
and relationship management
processes laid out for the marketing and sales agenda?
• Before resorting to pricing, has the
bank tested alternative non-price
incentives for moving a customer
down the appropriate path?
• How should product bundling be
used in the customer journey?
• Where can the incentive-based
“exchange” pricing logic be effectively applied to support current
and longer-term profitability?
Sherief Meleis is a Managing Director, and
Adam Stockton is a Principal at Novantas
Inc., a management consultancy based in
New York City. They can be reached at
[email protected] and astockton@
novantas.com, respectively.
Cross-sell Cash Management from Other Products?
It has been hotly debated whether the
core cash management relationship can
be originated off the back of other products. For example, can a bank transition a
new loan relationship into a primary cash
management relationship?
The answer would appear to be a
qualified yes. The discriminating factors
are the degree to which the customer is
highly price elastic and/or more emotionally invested in the purchase decision.
Mortgage is an obvious example.
The purchase and financing of a home
32
is a highly involved process, and price
is often paramount in selecting a mortgage provider.
If a bank specifies “moving an applicant’s core cash management relationship” as a pre-requisite for obtaining
the mortgage, acceptance at least sets
the stage for future customer relationship development — assuming the bank
follows through with activation and
engagement.
Realistically there are few such products. Mortgages or some other types of
event-critical loans are perhaps the only
examples. Credit card origination does
not provide much leverage unless there
is some loyalty connection, nor do highrate savings products. Finally, wealth
management is wrapped up in the brand
permissions of the bank and customer
confidence in the bank’s competence. It
typically provides very little leverage over
a customer’s cash management affairs.
— Sherief Meleis and Adam Stockton
Novantas Review is published quarterly by Novantas, Inc., 485 Lexington Avenue, New York, NY 10017.
© 2014 Novantas, Inc. All rights reserved. “Novantas Review” and “Novantas” are trademarks of Novantas,
Inc. No reproduction is permitted in whole or part without written permission from Novantas, Inc.
About Novantas
Novantas, Inc. is the leader in customer science and revenue management strategy for
the financial industries. A FinTech 100 Company, its Management Consulting, Solutions,
Data, and Research divisions specialize in investigating and interpreting customer needs,
attitudes, and behaviors in ways that help banks refine marketing decisions, customer
strategies, and sales and service activities, and to accelerate their immediate and ongoing
economic performance.
For more on these topics, view our
multimedia at: www.novantas.com
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