Saturday, October 29, 2016

Five Challenges to Your Bank of the Future and Ideas to Overcome Them

I recently spoke at a Financial Managers' Society (FMS) breakfast meeting on this subject and thought I would share my comments with you.

With all of our anguish, torment, debate, and deliberation about the future of our country, our industry, and our bank, here are some common themes that I have been seeing that can be improved should bank management commit to making them happen.

Forget the things outside of your control. These five themes are firmly within your ability to make a positive impact on your future.

1. We merge, citing economies of scale, but fail to realize them. In 2006, when the median asset size within my firm's profitability outsourcing service was $696 million, the operating cost per business checking account was $586 per year. In 2016, the median sized financial institution is $1.1 billion, and the operating cost per business checking account is $710. In other words, the financial institutions grew, and the cost per account grew. This is the theme across nearly every product category. Don't believe me, check your banks' expense ratio (operating expense/average assets) or efficiency ratio as you grew.

Idea: Create measurable incentives to support centers to provide more efficient support to profit centers and for risk mitigation. For example, deposit operations' expense as a percent of deposits should decline as the bank grows. Loan servicing expense as a percent of the loan portfolio should do the same. 

2. We over-invest in under-performing branches. I recently mentioned to a community bank management team that community financial institutions are slower to close branches because their decision making goes beyond the spreadsheet and market potential. Community bankers know the town mayor, and key business leaders. So they worry about other things that go beyond the fact that their branch in that market has little chance of being profitable. But allowing branches to operate at losses takes resources away from areas that need immediate resources, such as technology acquisition and deployment.

Idea: Develop objective analyses for entering markets. If the branch does not meet profit objectives within a reasonable period represented in the original analysis to open it, close it. Make it near-automatic.

3. Our brand awareness and customer acquisition strategy is moving at a turtle's pace, not the hare pace of the industry. In my firm's most recent podcast, we discussed the recently released FDIC Summary of Deposits data that showed, with all of the negative press surrounding large financial institutions, FDIC-insured banks with greater than $10 billion in assets moved from an 80.6% deposit market share in 2012 to an 80.7% today. This phenomenon was brought home when a banker told me that, in the Philly suburbs, Ally Bank was the most recognizable banking brand. Aren't they still owned by our government? 

Idea: Develop a clear message on what your bank represents and align your culture, and all sales and marketing channels to deliver your value proposition. 

4. We embrace complexity when we should be seeking simplicity. The decline in defined benefit pension plans combined with the increases in defined contribution (401k) plans, the abysmally low US savings rate (31% of non-retired people have no retirement savings), and the increasing complexity of running family and business finances presents an opportunity for community financial institutions to make their customers' lives simpler. We should start with ourselves. For example, when onboarding a customer, an FI can perform needs assessments, risk assessments (needed for risk management purposes), and customer capital allocation needs all at once, and add value to the customer relationship. 

Idea: At account opening, build an automated business process that includes the needed Q&A to assess customer needs that spurs post-account opening follow up, know-your-customer information, and risk assessments required to risk rate customers that assigns a rating that drives capital allocations to that customers' balances and rolls up to determine the bank's capital requirements.

5. We under-invest in the people that can build our bank. Because of over-investment in areas such as regulation and unprofitable branches, we under-invest in elevating the abilities of our employees to serve as advisers to customers, as highlighted above. Also, we tend to buy key people on the street, such as commercial lenders, rather than raising them within our bank, because of the time and resource investment needed to turn junior level people into productive commercial lenders.

Idea: Build a bankwide university that includes on-the-job training, web-based seminars, in-person training, and banking schools to create career paths for junior-level people that will reduce our need to buy senior-level people on the street, and elevate the skill sets of employees to actually advise customers, rather than only sell to them.

If I were to end this post with a theme, it would be urgency. We are past the time to lament about the interest rate and economic environment, and Dodd-Frank. They are outside of our control.

We are intuitively aware of the above challenges. The good news is we can do something about them. Address them this year, this month... no, this week! And your bank will move forward to an independent future for your employees, customers, and community. 

Did I miss any challenges within our control?

~ Jeff


  1. Jeff -- Another great post. Hopefully I am on the mark with your “any other challenges” question.

    I would add focus upon efficient deployment of capital. Community banks will never be bigger than their regional and national counterparts in our lifetimes, but they can provide superior returns to their shareholders by being smarter.

    This might be capital management 101, but I don’t hear it enough in the board room, so here is my idea to follow your theme.

    Don’t focus on total assets (size) focus on loans to assets (mix). In other words, improve ROE by replacing lower yielding surplus funds balance with risk-appropriate loan balance instead.

    Don’t focus on total deposits, focus on deposit mix. What portion of the balance sheet is comprised of relationship deposits (low cost checking and savings) versus rate sensitive funds (MMkt, CD/IRA and borrowings). In other words, improve ROE by lowering funding cost.

    Don’t focus on traditional fee and service charge income, instead, ask yourself each day, what products and services are our customers buying somewhere else that we could provide at a profit, even a small one. For example, consumers purchase identity theft protection, cell phone insurance, etc. Why don’t we bundle it with a fee-based checking account? We have an HR department in our bank, why can’t we provide outsourced HR services to our smaller commercial clients?

    Non-interest income exerts no pull on capital. If I can make a small profit on a marginal activity, product or service, especially if it is recurring in nature, I could care less that it makes my efficiency and expense to asset ratios look worse.

    Don’t let liquidity be a stop sign for your lending vehicle. If you are good at lending, then move items off the balance sheet to keep the lending engine running to maintain liquidity.

    Don’t look at total assets, look at assets under management – the sum total of assets, plus loans sold but serviced, plus loans participated out, plus wealth management assets under management.

    I know all of these things are easy to say, and hard to execute upon, but it all starts with focus; misguided focus will always lead to a sub-optimal outcome.

    1. Exactly the ideas I was looking for, Mike!

      "Assets Under Management" is right on, as many banks sell the guaranteed portion of SBA loans, keeping only the un-guaranteed portion on their books, and reap the one-time gain and the servicing income. This produces a capital efficient return while meeting customer borrowing needs.

      So long as the loans perform, of course.

      Thank you for the comment!

      ~ Jeff

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