AVOID THE BLIND SPOT: BANK PROFITABILITY BENEFITS FROM A MORE RIGOROUS APPROACH TO MANAGING CORPORATE CLIENTS

New research from Bain & Company finds that addressing the lowest-profitability 1 percent of clients can considerably improve a bank’s bottom line

New York – May 16, 2017 –The likely rise in interest rates over the next few years could lift the fortunes and profitability of the corporate banking sector. Yet, a new brief from Bain & Company, How Banks Can Turn Around “Unprofitable” Corporate Clients, finds that many banks have made little headway in realizing the full potential of their relationships with corporate clients – a detrimental blind spot that could greatly inhibit their ability to maximize corporate client profits when the economic tides turn. Bain’s research finds that even small shifts in a bank’s portfolio can have a significant effect on its overall profitability. In particular, addressing the lowest-profitability 1 percent of clients first can considerably improve the bottom line.

Bank profitability overall has significantly declined since the global financial crisis. In response, banks have focused much of their energy on revenue enhancement and cost savings – e.g., making good progress in slimming back-office operations but, according to Bain, they are under-prepared to capitalize on the huge opportunities that lie in a more rigorous approach to managing corporate client profitability.

“Leading banks are using this moment to streamline, which puts them in a pole position to take advantage of a strengthening economy,” said Jan-Alexander Huber, head of Bain’s Financial Service Risk and Regulatory Practice and co-author of the brief. “Rising interest rates will begin to cover up part of the low profitability problem among corporate clients but, at that point, the opportunity to address this issue becomes less obvious and urgent internally.”

Bain finds that, in the typical corporate portfolio of a large multinational bank, economic profit (measure of risk adjusted profit after the cost of capital) derives from roughly 20 percent of clients. Within that group, just about 1 percent account for most of the value. At the other end of the portfolio, some 30 percent of clients fall below the hurdle rate for economic profit, with about 1 percent having the greatest negative effect for the bank as it currently serves them. The remaining 50 percent or so have moderate value for the bank or just break even.

While the “lowest profitability” 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. Some banks have realized that a more effective route is to find the right model to make the relationship mutually sustainable. That happens through understanding clients’ current and future potential, having an honest dialogue, and drawing a clear decision map at the next refinancing or account review. Often, just knowing that the bank tracks economic profitability spurs a turnaround, because the client realizes they cannot get away with cheap loans and promises of ancillary business for long.

“Banks 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,” said Huber.

Still, he admits it is no small matter to get a reliable fix on client economic profitability. One challenge lies in the complexity of bank IT systems which makes it difficult to allocate operating costs or market risks to specific clients because of the myriad business units, databases and reporting elements involved.

A bank’s organizational culture often presents another major hurdle. Making a shift to emphasize economically profitable clients requires significant culture change. For example, some leading banks rebalanced their scorecards away from revenue growth alone (which motivates relationship managers to close loans at any price) to profit metrics (which focuses attention on the full potential of the relationship).

Banks that have been gaining control of their portfolio’s profitability generally have begun by categorizing clients into tiers, ranging from highly profitable to unprofitable based on economic profit potential and company size. Once the bank has sorted its client base into the tiers, the discipline of profitability should pervade the life-cycle of every corporate client.

According to Bain, this life-cycle includes four key phases:

• On-boarding. 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.
• Deal pricing. When weighing a loan or other product offer, the bank should look beyond the hurdle rate for the specific transaction to whether the deal is accretive or dilutive to the relationship.
• 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 profitability of the relationship together with estimates of the future potential. This profile feeds into a uniform planning process across the bank.
• 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.

“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 discipline into a historically loose and often overly personal process,” said Thomas Olsen, who leads Bain’s Global Corporate Banking and Market Infrastructure Practice and co-authored the brief. “Such rigor will allow banks to better free up poorly allocated capital and seize opportunities that will only grow larger as interest rates rise.”

Editor’s Note: To arrange an interview with Mr. Huber or Mr. Olsen please contact Dan Pinkney at dan.pinkney@bain.com or +1 646 562 8102.

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