Monday, May 01, 2017

Cultural Conversation in Banking

Are your incentives consistent with your strategy and culture?

I was recently interviewed by the Financial Managers Society on this topic, and as a lead-up to my presentation on the subject at the upcoming FMS Forum in Las Vegas in June.

Here are excerpts from the discussion.

FMS: Why is measuring account openings such a misguided endeavor?

JM: If a bank measures product profitability, costs follow activity. Those that don't measure product profitability intuitively tend to believe that the number of accounts drives the work more than balances, even though balances, for the most part, drive revenue in banking.

So if customer A comes in with $10,000, an accounts-driven institution would try to split up that $10,000 between two or three accounts so they can hit their targets. The profit-focused bank, on the other hand, would do what the customer originally intended, and open up that checking account knowing full well that they would get similar or equal spread on the $10,000 in the single checking account, but have less back-office expenses to absorb than if they opened three accounts.

FMS: Which numbers should matter in the quest for better profitability - and why?

JM: Co-terminous spread and direct pre-tax profit - and the trends for both - would create an environment to drive profitability rather than activity. Bankers typically hold lenders accountable for the size of their portfolio and their production. What if they were instead held accountable for the spread (after provision), both in dollar aggregate and the ratio, and the trend for each?

So if Lender A had a $50 million portfolio at a 1.25% co-terminous spread, or $625,000, would that be better than the lender with a $35 million portfolio, with a 2% co-terminous spread? The math says no. But who reaps more reward in today's environment?

FMS: Bigger picture, how can the right incentives lead to a better culture?

JM: We look for the path of least resistance in terms of meeting goals and incentives - it's human nature. If I'm a branch manager whose incentive kicks in if I grow branch deposits by 10%, then I'm looking to do that with the least resistance. So I might call my regional manager daily for CD rate exceptions to get that $200,000 CD, even though with the rate exception, that CD might have a five-basis-point spread.

On the other hand, if I was held accountable for growing my branch's co-terminous deposit spread, would I still chase the CD customer? Or would I maybe seek the operating account at the tire and battery shop down the street, even though that might bring 25% of that CD balance to my branch? Multiply that logic to every profit center within the bank. Now you have a culture!

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