Liquidity Observations for Banks as 2022 Closes

Investors must recognize that banks should generate and expand their revenues through the credit cycle, which covers and includes whatever problems and losses that may occur.

The increase in spread revenue and expansion of net interest margin was a significant theme from earnings reported after June 30, and will be for the rest of 2022. Yes, some deposit outflow has started; it seems natural for liquidity to decline from record levels reached throughout the earliest wave of the coronavirus pandemic. Recall: deposits increased more than 40% at all banks regulated by the Federal Deposit Insurance Corp. between December 2019 to March 2022.

At Janney, we’re focused on measuring how banks can tap funding sources beyond traditional deposit gathering. One important measure of a bank’s ability to borrow are “pledged” securities, which are pledged as collateral to another entity, such as the Federal Reserve or Federal Home Loan Banks. These securities are well below pre-pandemic levels, and slightly above their totals in the first quarter of 2022. By region, banks in the Mid-Atlantic have the highest percentage of securities already pledged; as a group, banks over $50 billion in assets had the lowest percentage of pledged securities. We also performed a distribution analysis that showed most banks have between 0% and 50% of securities pledged.

Banks of all asset sizes rely on the Federal Home Loan Bank system for contingent liquidity via credit lines and borrowings called “advances,” which effectively serve as wholesale funding and are an alternative to brokered deposits. To borrow from the FHLB, banks must post collateral in the form of certain types of securities, such as Treasurys, agency-backed securities and certain private label and municipal securities, or loans, generally first-lien mortgages, home equity lines of credit, certain commercial real estate loans and some farm loans. The banks are then subjected to internal risk-ratings that determine an ultimate borrowing capacity amount. The risk-ratings and limits differ among the 11 individual FHLBs, but we know from FHLB guidance that most banks are subjected to a 25% maximum borrowing limit.

Our analysis used FDIC call report data to pull all the individual security and loan categories eligible as collateral. We then applied the FHLBs’ haircuts to the collateral values in these various categories to determine total potential collateral. Finally, we subtracted already pledged securities and existing FHLB borrowings, which banks disclose in their call reports, to the typical maximum 25% borrowing limit to determine the remaining availability.

The bottom line? Median net FHLB borrowing capacity has incrementally declined in the second quarter of 2022 by a miniscule 0.2%, and still stands at a strong 23% — only 2 percentage points below the 25% maximum and 2 percentage points above pre-pandemic levels of 20.9% in the fourth quarter of 2019. Regionally, banks in West tended to have the highest capacity, while their neighbors in the Southwest had the lowest; by asset size, banks below $1 billion in assets tended to have the most capacity and the largest banks had the lowest remaining capacity, primarily due to existing borrowings. Finally, another distribution analysis shows most banks currently have full capacity at 25%.

We combined the two concepts of pledged securities and estimated FHLB borrowing capacity to reinforce that numerous banks still enjoy high borrowing capacity, with low levels of pledged securities. We are confident that financial institutions nationwide have superb “dry powder” to fund near-term growth opportunities for new loans and franchise expansion.

We also observed that brokered funding is quite low. The average use of brokered CDs to total deposits has dropped over the past decade, to currently about 4% to 5% of total deposits. This is another available tool for banks today to fund balance sheet growth, as interest rates and underlying spread revenues are much improved. Investors should keep in mind that brokered deposits are less expensive than FHLB funding currently. In fact, about 67% of banks reported no brokered funds at the end of June. If deposits decline as banks deploy excess liquidity, brokered deposits could be a key incremental tool to generating higher revenues that allow financial institutions to “earn through the credit cycle” — a critical concept all investors should be able to grasp. Fortunately for banks, plenty of liquidity capacity exists. The critical question is, “How will banks access and deploy their available liquidity?”

Getting the Most out of the Profitability Process

The banking industry is increasingly using profitability measurements and analysis tools, including branch, product, officer and customer levels of profitability analysis.

But a profitability initiative can be a considerable undertaking for an organization from both process and cultural perspectives. One way that institutions can define, design, implement and manage all aspects of a profitability initiative is with a profitability steering committee and charter — yet less than 20% of financial institutions choose to leverage a profitability steering committee, according to the 2020 Profitability Survey from the Financial Managers Society. Over the past 30 years, we have found that implementing a profitability process inherently presents several challenges for institutions, including:

  • Organizational shock, due to a change in focus, culture and potentially compensation.
  • Profitability measurement that can be as much art as it is science.
  • A lack of the right tools, rules and data needed.
  • A lack of knowledge to best measure profitability.
  • A lack of understanding regarding the interpretation and use of results.
  • An overall lack of buy-in from people across the organization.

The best approach for banks to address and overcoming these challenges is to start with the end in mind. The graphic below depicts what this looks like from a profitability initiative perspective. Executives should start from the top left and let each step influence the decisions and needs of the subsequent step. Unfortunately, many organizations start at the bottom right and work their way up to the left. This is analogous to driving without a destination in mind, or directions for where you want to go.

The best way for banks to work through the above process, and all the related nuances and decisions, to ensure the successful implementation of a profitability initiative is by creating and leveraging a profitability steering committee and related charter. There are three primary components of a profitability steering committee and charter. The first task for the committee is to define the overall purpose and scope of the profitability initiative. This includes:

  • Defining the goals of the steering committee.
  • Outlining the governance of the initiative.
  • Defining how the profitability results will be used.

The committee’s next step is to define the structure of the profitability process, including:

  • The employees or roles that will receive profitability results, based on the decisions to be made, the results they will identify, any needed metrics and reports and any examples of reports.
  • The tool selection process, including determining whether an existing tool exists or if the bank needs a new tool, documenting system/tool requirements, creating the procurement process details and ownership of the tool.
  • Deciding and documenting governance concerns that relate to profitability rules, including identifying the primary owner of the rules, the types of rules needed (net interest margin, costs, fees, provision or capital), the process for proposing and approving rules, any participants in the process and any education, if needed.
  • Identifying the data needs and related processes for the initiative, such as the types of data needed, the sources and process for providing that data, ownership of the data process and the priority and timelines for each data type.

The committee’s final step focuses on the communication and training needs for the profitability initiative, including defining:

  • A training plan for stakeholders.
  • A communication plan that includes how executive will support for the initiative, a summary of the goals, decisions that need to be made, and any expectations and timelines, as well as details of the process, as needed.
  • An escalation process for handling questions, issues or disputes, and the role that committee members are expected to play in the escalation process.
  • The help and support, such as personnel and documents. that will be available.

Additional Best Practices
When creating a profitability steering committee and related charter, we have found it helpful to consider the following items as appropriate:

  • If profitability results will be included as part of individual or team incentive compensation, be sure to work through the necessary details, such as process flows, additional reporting, required integration points and data flows, dispute management, additional education and training, among others.
  • Consider aligning any metrics, approaches and reporting structures if the budgeting and planning process forecasts profitability.
  • Document plans for assessing the profitability initiative over time.
  • Finally, keep it suitably simple. Expect to be asked to explain the initiative’s approaches, details and results; the bank can always increase the precision and/or complexity over time.

How to Reduce Application Abandonment and Grow Revenues

Banks drive significant portions of their revenues through products such as credit cards, mortgages and personal loans. These products help financial institutions improve their footprint with current customers and acquire new customers. The coronavirus pandemic has increased demand for these products, along with an excellent opportunity to improve revenues.

But applying for these offerings has become a challenge due to changes in the in-person banking environment and the limited availability of customer support outside traditional banking hours. Even though customers and prospects are attempting to apply for these products online, financial institutions are experiencing low conversions and high drop-off rates. Simple actions — such as an applicant not checking an agreement box or not having clarity about a question — are behind over 40% of the application abandonment instances.

Financial institutions can tackle such situations to improve the application journey and reduce instances of abandonment with products such as smart conversion that are powered by artificial intelligence (AI).

How Does Smart Conversion Work?
AI is being increasingly incorporated into various functions within banks to help tackle a variety of issues. Incorporating AI can enhance customer service, allowing customers to become more self-sufficient and quickly find answers to questions without long wait times or outside of bank hours.

In smart conversion, an AI-powered assistant guides applicants throughout the application process, step by step, providing tips and suggestions and answering questions the applicant may have. Smart conversion achieves this through its AI co-browsing capability. In AI co-browsing, the AI assistant snaps on to the application form and proactively helps fill out the application form if it sees a customer slow down. If an applicant has questions, it helps them at the moment of doubt and ensures they continue with the application. This enables applicants to complete the form with ease, without additional assistance from someone within the financial institution.

Say there is a portion of an application that stops an prospective customer in their tracks: They are not sure of its meaning. Smart conversion will proactively assist them with the clarification needed at that moment. Applicants can also interact with the smart conversion assistant at any time to ask questions. For applicants already in the system, the smart conversion assistant can autofill information already available about them, making the application process more seamless and efficient.

The smart conversion assistant provides complete flexibility to the bank to choose the parts of an application that should deliver proactive help to applicants. It also offers insights on the customer journey and details why applicants drop off — continually enabling financial institutions to improve the customer journey.

Better Business with Smart Conversion
Smart conversion helps financial institutions increase revenues and enhance the customer experience by assisting applicants and improving application completion rates. These tools have proven to increase conversions by up to 30% — a considerable improvement to financial institutions of any size.

Financial institutions must look at the current offerings in their technology suite and explore ways to incorporate valuable tools to become more efficient and grow. They should consider leveraging smart conversion to reduce application abandonment rates and the assistance needed from the call center or internal staff while growing revenues.

In a time when banks are fiercely competing for customers’ valuable business and relationships, AI-powered tools like smart conversion that can be set up easily and deliver results swiftly will be key.

PayPal Is Not a Bank. Or Is It?

Last Tuesday, payment company PayPal Holdings’ market capitalization of $277 billion was higher than the entire KBW regional bank index of $213.5 billion. This has been true for months now.

Tom Michaud, CEO of Keefe, Bruyette & Woods, noted PayPal’s valuation in a February presentation for Bank Director. “They can really afford to invest in ways a typical community bank can’t,” he said at the time.

PayPal’s market value is richer than several large banks, including PNC Financial Services Group, Citigroup and Truist Financial Corp.

But how can that be? When you compare the earnings reports of PayPal to the banks, you can see the companies’ focuses are entirely different. PayPal promotes its growth: growth in payment volume, growth in accounts and growth in revenue. Truist and PNC are more inclined to highlight their profitability, which is typical of well established, legacy financial companies.

Source: Paypal

Source: PayPal. Total payment volume is the value of payments, net of payment reversals, successfully completed on PayPal’s platform or enabled by PayPal on a partner platform, not including gateway exclusive transactions.

PNC reported net income of $7.5 billion, an increase of 40% from the year before, on total revenue of $13.7 billion in 2020. PayPal reported earnings of $4.2 billion in 2020, nearly double what the company had earned the year prior.

PayPal was trading at about 67 times earnings last Wednesday, while Truist was trading at about 19 and PNC at 28, according to the research firm Morningstar.

Of course, it’s silly to compare PayPal to banks. PayPal isn’t a bank, nor does it want to be, says Wedbush Securities managing director and equity analyst Moshe Katri. “It’s better than a bank,” he says. “What you’re getting from PayPal is a host of products and services that are more economical.”

Katri says PayPal, which owns the person-to-person payments platform Venmo, offers transaction fees that are lower than competitors. For example, PayPal advertises fees to merchants for online transactions for a flat 2.9% plus 30 cents. Card associations such as Visa and Mastercard offer a variety of pricing options for credit and debit cards.

Katri says PayPal’s valuation is related to its platform and its earnings power. PayPal has roughly 350 million consumers and about 29 million merchants using its platform, with potential to grow. Not only could PayPal expand its customer base, but it could also grow its transactions and fees per customer.

“It allows you to do multiple things: shop online, transfer funds, transfer funds globally, bill pay,” Katri says. “They offer other products and services that look and feel like you’re dealing with a bank.”

PayPal also offers small business loans, often for as little $5,000. It uses transaction data to underwrite loans to merchants that may appear unattractive to many banks.

But PayPal is more often compared to competitors Mastercard and Visa than to banks. Both Mastercard and Visa saw a decline in payment volume during the pandemic after losing some in-person merchant business, according to the publication Barron’s. In contrast, PayPal did especially well during 2020, when the pandemic forced more purchases to move online.

PayPal’s size and strength have helped it invest, including recent initiatives like an option to pay via cryptocurrency, a touchless QR-code payment option and a “buy now, pay later” interest-free loan for consumers.

PayPal CEO Dan Schulman said on a fourth-quarter earnings call that the company plans to enhance bill pay options this year and launch budgeting and savings tools. “We all know the current financial system is antiquated,” he said.

But the juggernaut that is PayPal may not ride so high a few years from now. Shortly after a February investor presentation where the company projected a compound annual growth rate of 20% in revenue, reaching $50 billion by 2025, the stock price skyrocketed to $305 per share.

It has come down considerably since then, along with many high-flying technology companies. PayPal’s stock sunk 20% to $242.8 per share at market close last Wednesday, according to Morningstar. Katri has a buy rating on the stock, assuming a price of $330 per share.

Morningstar analyst Brett Horn thinks PayPal’s long term prospects are less certain, even though few payments companies are as well positioned as PayPal right now. Competitors are active in mergers and acquisitions, getting stronger to go up against PayPal’s business model. Apple Pay remains a formidable threat.

On the merchant processing side, Stripe and Square are among the players growing considerably, too. What’s clear is that giant payments platforms may continue to erode interchange fees and other income streams for banks.

“The digital first world is no longer our future,” Schulman said in February. “It is our current reality and it will forever change how we interact in almost all elements of our lives.”

The Missing Piece in Customer Engagement Strategies

Usage of appointments in banking has increased significantly since the outbreak of the coronavirus, and is expected to continue in a post-pandemic world.

Appointments increased nearly 50% in the second half of 2020, according to customer usage data, allowing banks to manage limited branch capacity while ensuring the best possible customer service. For example, Middletown, Rhode Island-based BankNewport experienced a month-over-month increase of more than a 466% in appointment volume between March and April of last year, with numbers remaining steady into May 2020. The $2 billion bank noted that these appointments allowed them to prepare for customers, solving their needs efficiently and safely.

Now, nearly a year later, appointment setting is helping banks to meet the transformative and digital-centric needs of their account holders. Online appointments enable any customer or prospective customers to schedule high-value meetings with the right banker who is prepared to speak on a specialized topics. In addition, these appointment holders can choose their preferred meeting channel, such as in-person, phone or virtual. But, how does this translate to customer engagement?

Customer engagement begins when a question or task needs to be done. As the customer or prospect starts searches for an answer on a local bank’s website, banks can use appointment scheduling to ensure that customers have options beyond self-service or automated customer service to connect one-on-one with staff. By optimizing consumer engagement strategies with high-value appointments, banks can increase revenue, boost operational efficiency and improve overall customer satisfaction.

Increase revenue
Today, many branches are faced with the challenge of maximizing revenue opportunities with highly compressed margins. This leads banks to search for more cross-sell opportunities such as opening new accounts, loans or alternative revenue-driving sources.

Appointments help banks maximize these opportunities by connecting customers or prospects with the most knowledgeable service representative to handle sensitive topics, such as account openings or wealth management inquiries. Banks should take full advantage of these crucial meetings because engaged customers are more apt to expand their relationship with an institution when provided with the right resources at a time they’ve scheduled. In fact, TimeTrade SilverCloud data shows that appointment scheduling increases the likelihood that a person will move forward with a loan or deposit by 25% to 40%; customers and employees are better equipped for the meeting’s purpose and have stronger intent to transact.

Boost operational efficiency
Proper branch and contact center staffing levels allows banks to be more efficient without adding to the overall headcount. In the absence of appointment scheduling, employees can be burdened by prolonged rescheduling of meetings and correcting inconsistent information, stemming from unproductive customer interactions and resulting in wasted time.

Appointment scheduling allows employees to prioritize their time to address complicated issues and ensure their full potential is being used during business hours.

This can be further optimized with customer self-service. As more account holders reach a resolution without staff interaction, employees can spend more time with complex customer inquiries. Bank of Oak Ridge saw technology-related questions decrease by 64% after implementating a consumer self-service solution, allowing employees at the Oak Ridge, North Carolina-based bank to expand existing relationships and focus on more critical tasks.

Improve customer satisfaction
Like employees, customers’ time is valuable and their money is personal. When their time is wasted by a low-value interaction, this can greatly impact the overall customer experience. Negative comments about unprepared or ill-informed staff can be detrimental to an institutions’ reputation and consumer trust.

It is paramount that banks route customers to the employee best suited to meet their financial needs and questions. Banks that cultivate a comprehensive customer engagement experience, using online appointment scheduling, will be well equipped to meet customer needs and provide a great experience.

Banking by appointment is a powerful tool in today’s new business environment. Banking competition is increasingly prominent, and going the extra mile to make financial transactions and consultations as easy as possible will be an essential differentiator among institutions. Enabling customers to connect with the right person at their right time, and capturing pertinent customer information at the time of scheduling, allows banks to provide the right answer, resulting in more satisfied customers, better served employees and a healthier bottom line.

One Bank Reworks a Key Metric for the Pandemic Era

One of the most efficient banks in the country is measuring its performance using a new metric that captures how the pandemic has changed the operating landscape.

Johnny Allison, chairman and CEO of Conway, Arkansas-based Home BancShares, debuted a new metric during bank unit Centennial Bank’s third-quarter 2020 earnings announcement that measures the bank’s performance and earnings power. The metric provides insight into how well a bank is able to convert revenue into profits; it comes at a time when bank provisions and allowances remain elevated, and generally staid earnings results are lumpier and noisier than ever.

“I love the numbers and I love to play with them,” Allison says in an interview, describing how he came up with the approach. He was looking at the third-quarter earnings table for the $16.4 billion bank and saw total revenue and pre-tax, pre-provision net revenue listed near each other.

“When I looked at those, I thought ‘[Wow], look how much we brought down pre-tax pre-provision out of the total revenue of this corporation,” he says. “That got my attention. I thought ‘I wonder what the percentage that is?’”

The non-GAAP metric is derived from two items in the earnings statement: pre-tax net income, excluding provision for credit losses and unfunded commitment expense, or PPNR, divided by total net revenue. Allison calls it “P5NR” or “profit percentage.” An efficient operator, Home BancShares converted 59.28% of its net revenue into profits before taxes and provision expense in the third quarter of 2020. It was 59.19% in the fourth quarter.

The metric has its fans.

“[P5NR] measures how much of a bank’s revenue turns into profits before taxes and provision expense,” wrote Christopher Marinac, director of research at Janney Montgomery Scott, in an October 2020 report. “We favor this new metric since it shows [how] much $1 of revenue is turned into core profits — the higher, the better.”

P5NR is related to another popular metric on the earnings report: the efficiency ratio. The ratio measures how effectively a bank spends money; the lower the ratio, the more efficient a bank is. Banks can achieve a low efficiency ratio either through keeping costs low or increasing revenue, known as positive operating leverage. Home’s third-quarter 2020 efficiency ratio was 39.56%; it was 39.64% in the fourth quarter.

Allison calls P5NR the “reverse” of the efficiency ratio because a higher number is better, but ties the figure to positive operating leverage. He says Donna Townsell, now director of investor relations, did much of the work starting in 2008 that made the bank more efficient. While the efficiency ratio is still useful, PPNR and P5NR show how much revenue a bank converts to profits, especially in an environment with high credit costs.

P5NR also speaks to the industry’s focus on bank PPNR, which the Federal Reserve defines as “net interest income plus noninterest income minus noninterest expense.” In an interview, Marinac says the metric came into focus as part of the annual stress test exercise that big banks must complete — capturing the earnings at a bank before it deducts credit costs. It’s not surprising the metric has been popular with analysts trying to look past the lumpiness of quarterly results to the underlying earnings power of a bank. Building up reserves subtracts from earnings, and releasing them can pump up earnings — both activities that can make it hard to assess the underlying revenue and profits of a bank.

Home included the figure for third and fourth quarter 2020 earnings, along with backdated calculations for previous quarters, but is cautious about leading with it. Like many bank-specific metrics, it is non-GAAP — a profit calculation that doesn’t follow a standard, required calculation for companies to disclose under generally accepted accounting principles. Allison says Home also includes the number in its monthly profit and loss statement and plans to include it in future earnings reports.

Not surprisingly, Home BancShares is touting a metric that makes the bank look good. Marinac’s report pointed out that Home Bancshares had the best P5NR of all banks early reporting during the third quarter of 2020, but says the metric still has application for other banks.

“It’s not hard to do the math. When Johnny said it, it made a ton of sense,” he says. “It makes our job easy, and it’s a simple concept that everyone should follow.”

The Illusive Hunt for Revenue

Fintel.pngThe operating environment for banks is becoming increasingly inhospitable. Rising credit costs and falling interest rates threaten to squeeze profitability in a vice grip unless banks find new revenue sources.

This is why Bank Director’s second annual Experience FinXTech event and awards, hosted virtually at the beginning of May, highlighted fintech companies that are helping banks grow their top lines.

The event brought together bankers and technologists for demonstrations and conversations about the present and future of banking.

As a part of the event, Bank Director crowned fintech winners in seven categories, including Best Solution for Customer Experience, Best Solution for Loan Growth and Best Solution for Revenue Growth.

Fintel Connect won the final category: Best Solution for Revenue Growth.

The Canada-based company amplifies a bank’s marketing campaigns by leveraging an affiliate network of publishers and social influencers, as we explain on our FinXTech Connect platform, which profiles hundreds of tried-and-true technology companies serving the banking industry.

A selling point is that, instead of paying for clicks or impressions, customers of Fintel Connect only pay once a lead converts into an actual customer.

Canada’s EQ Bank has been working with Fintel Connect for years, using it to manage media affiliates — bloggers, interest rate aggregators, etc. EQ attributes the service with boosting customer acquisition “fairly substantially,” with between 5% and 10% of EQ’s new customers now coming through it.

Nest Egg was a runner-up in the category of Best Solution for Revenue Growth. The Philadelphia-based company enables banks to offer high-quality, fully digital investment services in order to increase customer affinity.

OceanFirst Financial Corp., a $10.5 billion bank based in Red Bank, New Jersey, liked Nest Egg so much that it invested in the company.

OceanFirst has recommended Nest Egg’s semi-automated money management tool to retail clients for about a year, with assets under management growing from $0 to $43 million over that time. The service is already cash flow positive for OceanFirst.

The last finalist for this category was Flybits, a fintech company based in Toronto.

Mastercard has been working with Flybits for a year now. They’re still in the early stages of implementing its product, which helps provide contextualized offers to end users of their cards for the purpose of driving usage.

The trajectory has been a positive one for Mastercard, leaving the company optimistic that working with Flybits will help their clients — mainly banks — increase card usage and associated fee income.

One reason Mastercard chose to work with Flybits is because of the way it deals with data. All data is tokenized, with Flybits only selectively accessing the data it needs. There are any number of ways for banks to grow revenue. These are three of the best, according to experienced panel of judges convened to choose the winners at Bank Director’s 2020 Experience FinXTech.

A New Opportunity for Revenue and Efficiency

Intelligence-Report.pngIn 2017, Bank Director magazine featured a story titled “The API Effect.” The story explained how banks could earn revenue by using application programming interfaces, or APIs, and concluded with a prediction: APIs would be so prevalent in five years that banks who were not leveraging them would be similar to banks that didn’t offer a mobile banking application in 2017.

Today, the banking industry is on a fast track to proving that hypothesis.

Banks are hurtling into the digital revolution in response, in no small part, to the outbreak of Covid-19, a novel coronavirus that originated in China before spreading around the globe. The social distancing measures taken to contain the virus have forced banks to operate without the safety nets of branches, paper and physical proximity to customers. They’re feeling pressure to provide up-to-the-minute information, even as the world is changing by the hour. And they’re grappling with ideas about what it means to be a bank and how best to serve customers in these challenging times.

One way to do so is through APIs, passageways between software systems that facilitate the transfer of data.

APIs make it possible to open and fund new accounts instantly — a way to continue to bring in deposits when people can’t visit a branch. They pull data from call centers and chat conversations into systems that use it to send timely and topical messages to customers. And they enable capabilities like real-time BSA checks — an invaluable tool for banks struggling to process the onslaught of Paycheck Protection Program loans backed by the Small Business Administration.

All those capabilities will still be important once the crisis is over. But by then, thanks to the surge in API adoption, they’ll also be table stakes for banks that want to remain competitive.

In short, there’s never been a better time to explore what APIs can do for your bank, which is the purpose of this FinXTech Intelligence Report, APIs: New Opportunities for Revenue and Efficiency.

The report unpacks APIs — exploring their use cases in banking, and the forces driving adoption of the technology among financial institutions of all sizes. It includes:

  • Five market trends driving the adoption of APIs among banks
  • Actionable API use cases for growing revenue and creating efficiencies
  • A map of the API provider landscape, highlighting the leading companies enabling API transformation
  • An in-depth case study of TAB Bank, which reimagined its data infrastructure with APIs
  • Key considerations for banks developing an API strategy

To learn more, download our FinXTech Intelligence Report, APIs: New Opportunities for Revenue and Efficiency.

Six Ways to Grow Treasury Department Revenue


retail-6-6-19.pngBankers looking to grow revenue from their treasury departments will need the support of branch staff to drive the effort.

Banks large and small sometimes struggle to maximize the lucrative opportunity of their treasury departments. To increase revenue, it is vital that employees in the branch discuss treasury products with new and existing customers. Here are six steps to get started.

Step 1: Create a Top-Down Directive
Everyone from the bank president to newly hired employees should understand the importance that treasury revenue plays in overall operations. Banks should not rely on branch staff to execute this initiative. Leadership must prioritize discussing and promoting treasury products if they hope to see a pickup in demand and improvement in revenue. All employees should be on board, and there should be a top-down directive from upper management on the importance of cross-selling treasury products.

Step 2: Set Goals and Metrics for Employees
After bank leadership has discussed the importance of treasury products and how they can serve customers’ needs, they should set measurable and attainable goals for branches and staff.

Banks should monitor and track the actual performance against the set goals over time and follow up on them. Recognize bank employees that meet or exceed expectations, which will boost motivation.

Step 3: Run an ACH Report
Tap into existing customers by mining Automated Clearing House data. Merchant services providers can provide a list of ACH descriptors that allows banks to identify customers who are using processing services outside the bank. From there, executives will need to determine what other products their existing customers are using. These leads are invaluable, and this is an easy way to identify cross-selling opportunities for existing customers who already have a trusted relationship with the bank. Banks should assign an employee to follow up with all the customers on these reports.

Step 4: Incentivize Referral Activity
Executives should incentivize their employees to promote treasury products through referral bonuses, commissions, referral campaigns and recognition. Use these campaigns regularly, but change them so they remain enticing for employees. One place to start could be with a quarterly referral campaign partnered with the current merchant services provider, which can be mutually beneficial and bolster excitement about treasury department offerings.

Step 5: Require Treasury Products with New Business Loans
Banks can also require customers to add certain treasury products as a loan covenant on new business loans. However, they should take pains to consider the needs of the prospective customer before requiring a product.

Adding this requirement means it will be vital to have treasury management specialists involved in initial meetings with prospective customers. After a proper needs assessment, they can craft a customized proposal that includes treasury products that will be of most use to the customer.

Step 6: Educate Staff
Bank employees will always be hesitant to bring up products that they do not fully understand, and may be concerned about asking questions. Education is central to combatting this, and the success of any effort to promote a bank’s treasury department.

Banks should implement cross-training seminars to educate all employees about product offerings. It should also be ongoing to keep employees engaged, and can include webinars, lunch-and-learns and new employee boot camps, among other approaches.

The Secret to a Low Efficiency Ratio


efficiency-5-31-19.pngOne of the most important metrics in banking is the efficiency ratio, which is generally viewed as a measurement of how carefully a bank spends money. Following this definition to its logical conclusion, the more parsimonious the bank, the lower its efficiency ratio should be.

But this common understanding fails to capture the true nature of what the efficiency ratio actually measures. It is in reality a fraction that expresses the interrelationship between the two most dynamic forces within any business organization: the growth of revenue and expenses.

Looked at this way, the efficiency ratio is actually a measurement of effective spending—how much revenue does every dollar of spending produce. And embedded within the efficiency ratio is a simple but extraordinarily important concept that is the key to high profitability—positive operating leverage.

But first, let’s look at how the efficiency ratio works. It’s an easy calculation. The numerator, which is the top half of the fraction, is expenses. And the denominator, which sits below it, is revenue. A bank that reports $50 of expenses and $100 of revenue in a quarter has an efficiency ratio of 50 percent, which is the benchmark for most banks (although most fall short).

However, not all 50 percent efficiency ratios are created equal.

Consider two examples. Bank Cheapskate reports $40 of expenses and $100 of revenue in its most recent quarter, for an efficiency ratio of 40 percent. Coming in 10 percentage points under the benchmark rate of 50 percent, Bank Cheapskate performs admirably.

Bank Topline reports $50 in expenses and $125 in revenue in its most recent quarter. This performance also results in an efficiency ratio of 40 percent, equivalent to Bank Cheapskate’s ratio. Again, an impressive performance.

While the two ratios are the same, it is unlikely that most institutional investors will value them equally. The important distinction is how they got there.

The argument in favor of Bank Cheapskate’s approach is simple and compelling. Being a low-cost producer is a tremendous competitive advantage in an industry like banking, which has seen a long-term decline in its net interest margin. It allows to a bank to keep deposits costs low in a tight funding market, or back away from an underpriced and poorly structured credit in a competitive loan market. It gives the bank’s management team optionality.

The case for Bank Topline’s approach is probably more appealing. Investors appreciate the efficiency of a low-cost producer, but I think they would place greater value on the business development skills of a growth bank. In my experience, most investors prefer a growth story over an expense story. Bank Topline spends more money than Bank Cheapskate, but it delivers more of what investors value most—revenue growth.

To be clear, the choice between revenue and expenses isn’t binary—this is where positive operating leverage comes in.

Positive operating leverage occurs when revenue growth exceeds expense growth. Costs increase, but revenue increases at a faster rate. This is the secret to profitability in banking, and the best management teams practice it.

A real-life example is Phoenix-based Western Alliance Bancorp. The bank’s operating efficiency ratio in 2018 was an exemplary 41.9 percent. The management team there places great importance on efficiency, although the bank’s expenses did rise last year. But this increase was more than offset by strong revenue growth, which exceeded expense growth by approximately 250 percent. This is a good example of positive operating leverage and it’s the real story behind the bank’s low efficiency ratio.

The greater the operating leverage, the lower the efficiency ratio because the ratio is relational. It is not solely a cost-driven metric. At Western Alliance and other banks that focus on creating positive operating leverage, it’s not just how much you spend—it’s how many dollars of revenue each dollar of expense creates.

To understand the real significance of a bank’s efficiency ratio, you have to look at the story behind the numbers.