Bank proﬁtability has taken a signiﬁcant hit since the global ﬁnancial crisis, forcing many banks to focus on cost savings. And they have made good progress in slimming branches, call centers and back-ofﬁce operations. They have made less headway, though, on realizing the full potential of their relationships with corporate customers. Now they are at an inﬂection point with the likely rise in interest rates over the next few years.
Higher rates could lift the profitability of corporate banking, yet many banks are missing a chance to make the most of this scenario. Huge opportunities lie in a more rigorous approach to managing corporate client profitability.
Most banks earn a 2% to 3% return on risk-weighted assets (RoRWA) in their corporate portfolio. Higher interest rates will increase the dispersion of RoRWA among banks, with the laggards holding level at best and the leaders potentially doubling their rate of return. If rates rise over the next few years to the point at which a bank lends at 5%, RoRWA could increase sharply, especially in the US and Europe, where rates have been very low.
The catch is that banks must make money in the meantime. They have to ﬁgure out which clients are proﬁtable today, which are not, and how to serve the latter group in a different way or move them off the books. Otherwise, banks will be limiting their upside on proﬁtable revenue growth.
Knowing where you make money
In a typical corporate portfolio of a large multinational bank, economic proﬁt derives from roughly 20% of clients. Within that group, perhaps 1% account for most of the value. At the other end of the portfolio, some 30% of clients fall below the threshold for economic proﬁt for the portfolio, with about 1% having the greatest negative effect for the bank as it currently serves them. The remaining 50% or so have moderate value for the bank or just break even (see Figure 1).
The lowest proﬁtability clients often account for a sizable share of a bank’s risk-weighted assets. Typically, the bank has made large loans at favorable rates and terms, without getting ancillary, higher-margin business—such as transaction banking, risk management or advisory services—in return. The level of proﬁtability will also depend on factors that ﬂuctuate over time, including the cost to serve, the dynamics and cycle of the client’s industry, and market interest rates. Many banks, though, lack a system that can systematically track the ebb and ﬂow of value for each client.
Small shifts in the portfolio can generate a signiﬁcant effect on overall proﬁtability. In particular, addressing the lowest-proﬁtability 1% of clients ﬁrst can considerably improve the bottom line. While these clients may be few in number, they tend to be large both in their size and the amount of revenue they generate for the bank; avoiding their business might not be a viable option as the bank needs coverage for its ﬁxed cost base.
IT and cultural challenges
It’s no small matter to get a reliable ﬁx on client proﬁtability. One challenge lies in the complexity of bank IT systems that have been assembled through years of one-off decisions and acquisitions. As a result, while most large banks can attribute revenue or credit risk to speciﬁc clients, few have a sophisticated system that can allocate operating costs or market risk to those clients because of the myriad business units, databases and reporting elements involved. Banks often ﬁnd it difﬁcult even to match a client identiﬁer across multiple data sources or to aggregate subsidiaries in different geographies up to a single corporate parent. Building a reliable infrastructure thus can prove to be a signiﬁcant competitive advantage.
Besides banks’ unwieldy IT systems, their organizational culture often presents a major obstacle. Historically, when banks earned healthy proﬁts, it was acceptable to manage through revenue alone. The ﬁnancial crisis spurred a shift to signiﬁcant cost takeout and a focused effort to shore up the balance sheet and reduce defaults. Today, making a shift to emphasize proﬁtable revenue entails a major cultural change. Some leading banks have reexamined their compensation packages to align the incentives of relationship managers with those of the business. They have rebalanced their scorecards away from revenue growth alone (which motivates relationship managers to close loans at any price) to proﬁtable revenue (which focuses attention on the full potential of the relationship).
Managing through the client life cycle
Banks that have been gaining control of their portfolio’s proﬁtability generally have begun by categorizing clients into tiers based on economic proﬁt and company size (see the sidebar, “What leading banks do differently”). The tiers range from highly proﬁtable (or high potential proﬁtability for new clients) through moderately proﬁtable to unproﬁtable (see Figure 2). Proﬁtability models use some combination of data on revenue, RoRWA and return on equity.
Once the bank has sorted its client base into the tiers, the discipline of proﬁtability should pervade the life cycle of every corporate client (see Figure 3).
Onboarding. When a bank is deciding whether to bring on a potential new client, calculating expected proﬁtability should be a routine part of the decision. Onboarding has become a more expensive process because of compliance, regulatory and user experience considerations, so it should be undertaken only when a bank can expect to have a sustainable relationship. The onboarding assessment will include indicators such as client size; typical needs for transactions, trading, bank guarantees or contingent loans; and the share of wallet that the bank can reasonably expect.
Deal pricing. When weighing a loan or other product offer, the bank should look beyond the marginal contribution for the speciﬁc transaction to whether the deal is accretive or dilutive to the relationship.
One global bank has integrated a pricing tool with its customer relationship management (CRM) system to pull historical data about a client’s past deals and proﬁtability. Certain elements, such as the bank’s desired proﬁt level, are automatically programmed in so that the tool produces a marginal contribution for the client as well as the expected future proﬁtability. This bank also uses rules-based decision making that limits exceptions on individual deals.
While many banks have processes to steer negative-contribution deals to a committee or senior approval, their monitoring of ancillary business consists of manual tracking and inputs. Deal-pricing systems should automatically capture promised ancillary deals in the CRM system and allow tracking all the way through delivery of the deal. That helps limit the ability of individuals to overpromise and underdeliver.
Account planning. Most corporate banks rely on an annual account plan to inform their budgeting and capital planning cycle. But best-practice banks also collect information on historical client revenue and the proﬁtability of the relationship along with estimates of future potential. This proﬁle feeds into a uniform planning process across the bank. Larger clients will require more detail, by subsidiary and product (because different deal teams and business units get involved), with a higher burden of proof on the relationship manager. Account plans for smaller clients can be handled through a more automated process that prepopulates required ﬁelds yet still allows judgment calls on the margin.
The account plans inform many client decisions over the following year, such as the pricing of speciﬁc deals, coverage level and a broader discussion of other product offers. In the best case, the CRM system can automatically create a projected account plan based on the previous plan. That means staff don’t have to ﬁll in every item from scratch and can update the plan at any point as circumstances change.
Client management. Not all clients will be proﬁtable every year given the nature of ancillary deals and the cyclicality of demand. So leading banks take a two- to four-year view. Of course, taking a longer view does not imply avoiding active portfolio management, including the occasional difﬁcult conversation. The good news: Dependable metrics give a bank conﬁdence that its honest engagement with the client is grounded in solid economics.
An effective practice we have observed at another global bank is how it uses the CRM system as an intermediary between relationship managers and service functions such as the credit or internal capital teams. For example, if the proﬁtability of a client drops below a certain level, the team responsible for overall proﬁtability asks the relationship manager to devise an action plan housed in the CRM. When that manager logs in, an alert will prompt him to create the plan. The team can review it, share it with a senior committee if need be and respond through the CRM. Everyone shares the same information, knows what has been committed and what to track.
It’s never easy to nudge a client to proﬁtability or to cast them loose if the bank cannot serve them proﬁtably. But having solid data to present to the client and an explicit plan to turn things around injects rigor into a historically loose and overly personal process. Such rigor will allow banks to seize opportunities that will only grow larger as interest rates rise.
Best practices for managing client proﬁtability have emerged among leading banks.
- Pricing is based on a combination of the individual deal’s proﬁtability and overall client proﬁtability.
- The bank gives preferential pricing only when there is a clear strategy to improve proﬁtability.
- Other decisions, such as onboarding and service levels, are based on overall client proﬁtability, commercial opportunity (as measured by share of wallet, balance sheet, and proﬁt and loss analysis) and strength of the relationship.
Process and governance
- A clear process exists to review and update the account plan.
- Exceptions are limited for negative-contribution deals, and promised ancillary deals get tracked.
- Incentives for relationship managers link to proﬁtability metrics.
- Finance is responsible for the integrity of data, models and assumptions, while the business units are accountable for the decisions.
- The institution uses a centralized global currency and accounting standard rather than individual booking centers with regional standards.
- Cost allocation reﬂects the true level of effort required to acquire and serve the client.
- The bank explicitly allocates market risks in addition to credit and operational risks.
IT systems and data
- All units in the bank use a consistent source of data. Automated and manual check processes assure data quality and completeness. The system produces timely data that gives managers an accurate picture of the client relationship.
- The management information system has advanced functionalities such as the ability to view client proﬁtability at different levels (by country, by relationship manager and so on) and an intuitive, graphical user interface.
- IT architecture has sufﬁcient ﬂexibility to accommodate future changes.
Jan-Alexander Huber, Iwona Steclik and Thomas Olsen are partners with Bain & Company’s Financial Services practice. They are based, respectively, in Frankfurt, London and Singapore.