Strategies, Best Practices and Thought Leadership

Understanding your Institution’s Unique Profitability

Understanding your Institution’s Unique Profitability

As the leader of your financial institution, do you know which products or branches are profitable, breakeven, or struggling? Is marketing looking for direction on what products to emphasize, or who should be targeted? Should pricing be altered or tiered, and at what levels? How does your financial institution use “big data” to make informed decisionsAre you growing in the right way, and how to measure success or failure? 

Profitability is no longer a black box of mystery built on conjecture or averages.  Rather, we build the rules and structure with your input with files created from the financial institution’s core system. Transactional data is the key input making the output current and informational. Not every checking account has the same profit, nor does two checking accounts with the exact same current balance or average balance. Baker Hill Analytics creates an income statement for every account at the financial institution with transactional data that drives the income statement onto the balance sheet. 

Understanding and directing the rules of funds transfer pricing (rules surround allocating net interest margin) is critical. While on the accounting ledger, deposits cost the financial institution money, they are a critical piece regarding the profitability and need to have a positive net interest margin allocated to show the symbiotic relationship loans and deposits have with each other.   

To illustrate the importance of funds transfer pricing (FTP) imagine a financial institution with one savings account and one auto loan. With simple accounting, the sole savings account of $10,000 paying a 1% dividend would have the savings account costing the financial institution about $100 and having a negative profitability. Simultaneously, the institution’s one auto loan of $10,000 making 4% weighted interest rate earns from another customer the financial institution $400 and likely having a positive profitability. Simple accounting is not the answer, thus the need for a FTP to split the net of interest income minus interest expense. A very simple method would allocate $150 to each of these two accounts.   

As one can imagine, splitting the difference may be better than the accounting method of keeping interest expense on dividends and interest income on loans, but most financial institutions prefer a more sophisticated and flexible model. An analytics model needs to have options and be flexible within those choices to be able to create an understandable methodology that reflects the value of the financial institution. There are several ways to allocate and no one way is the right way.    

There are many ways to allocate net interest margin from a simple and powerful method utilizing the traditional sources to the complex use of multiple yield curves of matched funding. The important aspect is to understand and be able to adapt the rules to reflect the situation and values of your institution.   

The trend of using big data and transactions to allocate non-interest income to the customers who create the income is not just a fad. This has become more of a necessity to price products and hit the market with the right products at the right time. Additionally, the usage of delivery channels is imperative to include in your database along with the tracking of customers who do not use online banking or mobile banking versus the customers who prefer to visit brick and mortar branches. 

Gathering and using the big data from your institution is critical using transactional data and gathering at the account level is critical to understand your profitability.  Your general ledger is unique along with who your customers are. Using benchmark averages is not the way to understand who and what products are driving your profitability up. 

It is critical to act now on profitability and not use a “peanut butter spread” approach or a market average. Baker Hill Analytics informs the senior leadership, enabling data-driven discussions on how to best use resources that considers profitability a primary objective.  

Topics: Analytics, Pricing & Profitability

Jeff Dwornicki

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