Banks want to maximize profits from their small business efforts. This newsletter provides a brief “profit maximization” checklist for banks to follow, whether they are organized on a geographic or functional basis. Our view is that, if a bank ensures that these practices are followed across the bank, its returns on small business will increase substantially.
Operating with discipline and consistency continues to be an elusive goal for many banks. In general, bank management allows local market heads to “interpret” corporate-born strategies whether related to consumer or business banking. Of course, by its very nature small business banking requires a local touch for those players who are developing relationships rather than focusing on selling specific products such as cards, mortgages, or high yielding deposits. However, the best-performing banks operate with the belief that consistency and discipline are not in conflict with a strong local presence. These banks provide local executives with a framework concerning what to sell, how to sell it, and to whom.
Below we provide a list of actions that banks should ensure are occurring across all geographies and branches. Without these actions, we think it likely that your small business group is underperforming against its potential.
* Price loans based on deposit levels. For various reasons, relatively few banks apply anything but the most rudimentary risk-based pricing to small business loans. The competitive environment and, oftentimes, a limited information base curtail this approach. However, banks can easily price loans based upon the deposit levels of their customers. Several banks we know do so, offering a two- or three-tier pricing structure based upon the amount of balances on deposit.
Of course, to make this work, the bank must monitor balance levels on an ongoing basis. The good news is that, on a portfolio basis, most customers maintain the agreed to balance levels, providing the banks with an attractive deposit source.
Management action: Establish and enforce guidelines linking loan pricing with deposit levels.
* Require direct debit for loan and interest payments. Does your bank fund its loans by placing those funds into the customers’ accounts or by giving them a check? Does the bank drive deposits into its accounts by requiring direct debit of loans and interest payments? Do you allow exceptions to this policy? The best answers are yes, yes and no.
Management action: Ensure all loan customers have demand accounts and sign on to direct debit. Monitor compliance.
* Require deposit hurdles for incentive payments. If you want to increase deposits, set a performance hurdle tied to deposits. Basically, before a branch banker or RM qualifies for an incentive he/she should generate a certain level of net new deposits. Lots of loans but insufficient deposits means no incentive. Conversely, lots of deposits but insufficient loans may result in an incentive. This approach places a clear and well-communicated emphasis on deposit generation.
Management action: Alter compensation to highlight the importance of deposits. Communicate this change. Don’t blink when some career lenders object.
* Tie the level of incentives to the economic attractiveness of deposits. Not all deposits are created equal. DDA accounts paying zero interest are usually preferable to sweep account deposits. Smart banks vary their banker basis points of incentive based on the likely profitability of different deposit types.
Management action: Tier deposit payouts.
* Make sure your first sale is a multi-product sale. Several years ago, one bank’s internal study showed that when a customer comes into a branch to open a business checking account, that is exactly what they do: open a checking account and no more. Increasingly, banks are now trying to program their branch personnel to sell multiple business and personal services at the time of DDA account opening. Many of these are easy sales that serve to tie the customer to the bank, including business debit, online banking, and overdraft protection.
Management action: Establish checklist for product cross-sales related to account opening. Track and pay for multi-product customer penetration.
* Sell to the owner and the business from day one. Again as part of the account opening process, more banks are creating a package that links the owner and the business, thereby encouraging owners to bring their personal business to their business bank. Higher consumer deposit rates and lower borrowing rates support this effort.
Management action: Make certain product packages tying together the owner and business. Track and pay for cross-over relationships, what one bank termed “Gemini Customers.”
* Apply auto-decision-making for all loans up to $50,000. “Touching” small business loans is expensive; from a risk perspective it is also largely unnecessary. Auto-decisioning has now been time tested, and it works. Applying a commercial lending approach to small business lending erodes and perhaps eliminates the profitability of those loans. Bankers touch these loans more than they need to; each touch brings added expense dollars.
Management action: Insist on implementation of auto-decisioning ASAP. Set a schedule to increase auto decisioning to the $75-100,000 level over the next 12 months.
Concluding Comment
If your bank is already pursuing each of the steps outlined above, congratulations are in order. While the list of “to dos” can be continually lengthened, your bank has already established itself as a profit leader and one that sets the pace for its competitors. However, the likelihood remains that your bank is not doing all these things, certainly not consistently. There lies a near-term profit opportunity. Who today can afford to resist approaches that our clients have used to increase deposits and margins dramatically?