This article will focus on simplifying customer profitability analysis for banks.
Just what is that account worth to you? A rich man was walking through the streets of New Delhi one day when he happened upon a beggar. The beggar had reached out his hand and asked, “A few grains of rice for a poor and starving man?”
At first glance, you would have thought that the rich man would have passed the offensive smelling obstacle without giving him a second thought. Amazingly, he stopped. He asked to see what the worthless man had in his cup. Five grains of rice were all that he had to his name.
Reaching into his pocket for what appeared to be lint or something, the rich man held out his clenched fist and proposed a trade. “You give me what is in your cup and I will give you what I have in my hand.”
With a crowd now assembled, the old beggar thought to himself, “Whether I die today or die tomorrow from hunger, what do I have to lose?” So he agreed to the trade and asked to see what trick had been played on him today for all to see.
With that, the rich man opened his hand to reveal a twenty carat diamond. Watching the rich man walking away, the penniless man was now worth $2 million and could buy all the rice he ever wanted. As the terminally ill man with only days left looked at his five new grains of rice, he felt like he was on cloud nine. Doing kind deeds for people, he was finding out, was priceless.
Now assuming that your customers are only worth a few grains of rice or a twenty carat diamond based on how big their account is or where they shop is tempting but will in many cases lead you to the wrong conclusion.
Knowing your customer profitability is crucial in many ways. If they are costing you money, you may want to sell them another account or service. You should not be waiving any fees on their account. If they are making you money, you will want to make sure you retain them with excellent service and be willing to give them a price break every now and then to show them your appreciation.
So what are the key ingredients to customer profitability? The most basic answer is revenues minus expenses. The problem arises from how much revenue you assign to your customer as well as how much expense. Typically, the only pieces of the equation tied to the customer’s accounts are interest income and fees from loans, interest expense and service charges from deposits, and other non-interest income fees from things like safety deposit boxes and trust accounts.
What is missing from the equation is the investment income from the deposits collected, the borrowing costs of the loans lent out, and the various costs of all the activities done to service all of your customers’ accounts. A more complete equation to the profitability question would be as follows:
[Interest Income from Loans + Investment Income from Deposits Collected]
[Fees from Loans + Service Charges from Deposits + Other Non-Interest Income]
[Borrowing Costs for Loans Lent Out + Interest Expense on Deposits]
[Cost of Activities to Service Your Customers’ Accounts]
That seems complicated! Break it down for me. Simplifying Customer Profitability Analysis for Banks will require three pieces and an easy-to-use report writer to put it all together.
- Data Warehouse – The first piece of the puzzle will require a data warehouse to gather all the specific items associated with the customer’s accounts into a single database. These are all the items that are in italics in our formula. Typically, you will have a loan module to keep all the data for loans. Another module for the Deposits. Still others that will track the other types of accounts and services that are offered to the customer. You will also have a module that puts all the accounts together to form the household such as a CRM or an MCIF.
- Funds Transfer Pricing– The second piece is the ability to assign investment income to the deposits gathered and borrowing costs to the loans lent out. A super simple approach I have seen is using the monthly Federal Funds rate plus 150 basis points as both the investment rate and borrowing rate. A more sophisticated approach is to use the monthly average US Treasury Yield curve to match expected maturities of your various term deposits gathered and loans originated during the month and use the Fed Funds approach for Demand Deposits and Prime Based Loans. Whatever method used, you will need to post the rates to your data warehoused loans and deposits to calculate the net interest margin.
- Activity Based Costing– The transactions on your various loans, deposits, and other accounts will be loaded into your warehouse. You will need to then assign costs to the various transactions. I have seen some folks make it super simple by assigning a $1 cost to all machine transactions such as online banking and ATM transactions while assigning a $5 cost to all teller transactions. As far as origination costs for your loans, apply what you are using for SFAS 91 purposes. If you want to break these out into more categories, group them into time-based groupings. For instance, activities that take from five seconds to two minutes should be one group. Three minutes to 10 minutes would be another one and so on. I typically see folks assign the associated pay rate of the individual doing the task with a markup of 150% to cover overhead. The goal is to keep the rates simple. Assign the rate against the activities to come up with the costs and again write it back to the data warehouse.
- Easy-to-use Report Writer – Now that everything has been loaded to your data warehouse, the real fun starts. Using a tool such as Excel to layout your report makes the most sense as virtually everyone is already conversant with it. Software vendors will usually provide this as an add-in to Excel that gives your spreadsheet direct access to the data warehouse with drill-down capabilities.
- Web Portal– An over-the-top component to the puzzle would be the use of a Web Portal that puts all the reports in one place that is easy to access for all your end users. That way, your staff will not have to hunt through Windows folders, past e-mails, or printouts to find a customer’s profitability. Logging into a web portal and typing in a customer number or name while they are present will be key to quickly knowing who you are dealing with.
So who can help? There are many vendors that offer data warehouses with an Excel front end that help you Simplify Customer Profitability for Banks. IBM offers Cognos, TM1, and other pieces that will allow you add the Funds Transfer Pricing and Activity Based Costing. Oracle offers Hyperion, OBIEE, and other modules that will do the same. Likewise, SAP offers BusinessObjects and BPC with additional modules.
If you want to all the tools combined in one solution with a Web Portal to boot, you may want to consider BI360 by Solver, Inc. Solver, Inc. is happy to answer any questions and generally review BI360’s easy-to-use, Excel- and web powered enterprise reporting and planning solution with a Web Portal for banking and finance industry users. So whether you have a customer that is worth a few grains of rice or a 20 carat diamond, you need a tool that will simplify profitability analysis so you can start making good decisions.