Traditional sources utilize the institution’s individual loan account interest rates compared to an overall cost of funds; while the institution’s individual deposit account interest rates compared to the overall yield. In this methodology, deposits are evaluated as a single source of funds and loans/leases are evaluated as a single use of funds. Each pool is assessed relative to one another on an account-by-account basis, where the specific rate on a given deposit account is assessed relative to the overall yield of the institution, and the specific rate on a given loan/lease account is assessed relative to the overall cost of funds of the institution.In this methodology, no external market rates are used, and the overall cost of funds and overall yield are calculated directly from the institution’s GL. This method is simple and gives the institution simple marching orders on growing the Balance Sheet knowing where the break-even will consistently exist for each product and its individual profitability characteristics from Non-Interest Income fees.
Are there more complicated methods? Yes. But the traditional sources work well and work well for the majority of institutions, giving senior management a clearer view on how best to grow. Senior leadership should find a tool such as Baker Hill NextGen Business Intelligence that has the flexibility and agility to do both simple and complex margin allocation that will work for your institution.
I thought Track Changes to the above may be confusing, so I retyped/rewrote it below:
Traditional banking methodologies like Funds Transfer Pricing (FTP) measure the performance of each funding source toward an institution’s overall profitability. For example, individual account interest rates are compared to an institution’s overall data—loan/lease rates to cost of funds, and deposit rates to yield. In this simple methodology, loans/leases are evaluated as a single use of funds, and deposits are evaluated as a single source of funds. Each pool is assessed relative to one another on an account-by-account basis. No external market rates are used, and the overall cost of funds and yield are calculated directly from the institution’s General Ledger.
This straight-forward method gives a financial institution the data it needs to grow its Balance Sheet, as where the break-even point will consistently be for each product is known.
There are more complicated methods to determine a path toward business growth. But they can sometimes be, well, unnecessarily complicated. Because traditional approaches like FTP work well for most institutions, the ideal solution would provide ways for management to easily assess profitability yet also extend their data analysis through more advanced features.
Yes, simple can work. But it works even better when powered by tools like Baker Hill NextGen Business Intelligence, which has the flexibility and agility to do both simple and complex margin allocation.