Attracting Deposits from Small Biz

BY CHARLES B. WENDEL

In the world of small business banking, attracting deposits is the name of the game.

| SYNOPSIS | Historically, banks have marketed loans rather than deposits to their small business customers. But deposits actually generate the most profitability from these customers, 60% of whom don’t borrow at all. Five tactics for improving the deposit flow are: a simplified product set; emphasis on product packaging; more effective deposit sales efforts; segmenting the market appropriately; and aligning incentives with deposit sales.

Small business is widely acknowledged in the banking industry to provide a fertile source of desirable customers, since small business owners often bring their personal business with them into the relationship.

Related Charts Deposits Drive Small Business Profitability Picking the Right Segment

What’s not often recognized is that small business, defined as companies with annual revenues below $10 million, also provides a rich source of deposits. Yet, historically, banks have led with lending to this segment, even though 60% of small businesses never borrow at all. Too few banks intensively target small businesses for their deposits.

This must change, given the struggle banks face in the current interest rate environment to raise low-cost deposits. The Federal Deposit Insurance Corp. recently reported that demand deposit growth declined by more than 4% between 2005 and 2006. Where are these deposits going?

Competitors, which include non-banks such as ING and Merrill Lynch, are focusing on customers with high levels of balances that can be invested. Additionally, many banks are aggressively pursuing share growth by offering high rates to lure depositors. Such appeals resonate in today’s market, particularly with small business customers, who strive to maximize the available interest income, both for their companies and themselves.

When interest rates on checking accounts were in the 1% range, many customers either did not notice or did not believe reinvestment in higher yielding accounts was worth their time or effort. With rates in the 5% range, some of these same customers have reached their “tipping” point.

Nevertheless, banks that recognize the value of small business deposits can take practical and effective measures to protect the deposits they have and also encroach upon competitors. Understanding the key profit dynamics of this business and how to focus on exploiting those opportunities can result in outsized returns for bank players.

Combining a strong product suite with a targeted and motivated sales force that has the requisite incentive system will result in deposit growth. Developing an effective deposit focus requires incorporating product development, marketing, support and staffing in the initiative.

Specifically, banks need to evaluate their current product set to ensure that the fundamental product offer is competitive while considering how best to simplify what is often an overly complex product set. Product managers should then assemble the individual products to create a package that differentiates the bank and highlights the key products that the bank wishes to emphasize. A targeted effort aimed at small business deposit sales will communicate the importance of the deposit effort to the entire bank while focusing a sales initiative on this critical area.

Incentives come last in this list but may deserve much higher placement. Too often, banks venture down a sales path without sufficiently aligning incentives with stated goals. Not surprisingly, this results in underachieving against those goals.

Two Rules
In evaluating how best to approach the small business segment, first consider the following two “rules” that we think must guide a bank’s efforts in this arena:

Rule One: Deposits drive profitability. Banks evaluating their small business portfolios find that most of their profits derive from deposits (see chart “Deposits Drive Small Business Profitability”). Furthermore, the higher the deposit-to-loan ratio, the stronger the segment’s return on equity (ROE). One analysis indicates that banks with a 2:1 deposit-to-loan ratio generate an ROE of 20% while those with 3:1 deposit-to-loan ratios generate ROEs in the 30% range.

Even in a higher rate environment, small businesses continue to be a major source of low-cost deposits. At most banks, 60% or more of all small business customers don’t borrow but do provide a funding source for their banks. Many of these customers lack treasury or cash management expertise and, therefore, often manage their available funds less aggressively than middle market or corporate players.

The best small business groups understand the value of deposits and have developed targeted programs aimed at their retention and growth.

Rule Two: Each small business is not of equal value to a bank. The 80/20 rule, which holds that 20% of customers contribute 80% of profitability, applies to small business - as well as to virtually every other segment we analyze.

Certain industry segments usually generate higher returns than others due to the balance levels they provide and their operational requirements. For example, most banks favor services firms, in particular professional services, over industries like retailing. The reason is professional services firms provide relatively high balances, have a strong credit history and offer attractive cross-sell opportunities aimed at the owner and other professionals.

In contrast, many banks (though, as we will see later, certainly not all) view the retail industry with some reticence due to its operational intensity and perceived higher risk. Our point is that a bank needs to pursue a segmented approach to maximize its profit performance and that priorities will differ for various banks.

Five Tactics
The following five tactics, some of them inter-linked, can result in improved deposit performance with small business customers:

1.  Assess and simplify the product set
Not only does small business profitability rely on one product class, deposits, but the deposit and cash management product requirements of most small businesses are relatively simple and straightforward. Similarly, the product set itself needs to be as simple as possible, both for the customer and the bank’s staff.

Branch and small business personnel often are expected to know and sell 100 or more products, clearly an unrealistic expectation. Therefore, reviewing the product set to determine which products are critical to the customer and at the same time are the most profitable has become a foundational requirement for deposit sales success. For example, RBC Centura, a subsidiary of Toronto-based Royal Bank of Canada, recently reduced its deposit product types from twelve to four. Similarly, other banks have focused on streamlining the onboarding process to make account openings as easy and quick as possible.

The fact is, in the small business space, individual products will not provide significant differentiation from one bank to another. However, product packages and segmented marketing approaches can create a unique offer and a sustainable competitive position.

2.  Emphasize product packages
Banks that introduce targeted product packages both meet a wider range of customer requirements related to deposits and loans and reduce account turnover.

Small business provides an almost unique opportunity for bankers to broaden their marketing aim beyond the commercial account to the personal needs of the employer/owner and employees. At some banks, up to 40% or more of branch profitability results from the combined impact of business from the company, owner and employees.

Increasingly, banks focus on offering a set of personal and business capabilities rather than a single product. Banks learned that the once popular “free” business-checking product attracted customers based on low cost rather than relationship value. Not surprisingly, turnover in these accounts has been high and many banks are no longer pursuing the customer who is prone to jump for lower costs. Instead, the best banks are now emphasizing product packages or suites that can differentiate the bank and draw in deposit balances from both the business and the business owner.

Examples include London-based HSBC Holdings plc, with its financial services offer for legal professionals, and Atlanta-based SunTrust Banks Inc.’s Medical Private Banking offer for medical professionals, which focuses on both personal and business needs.

The SunTrust offer organizes its marketing focus into “services for your practice” and “personal services.” Services for the practice include leasing and partnership loans that are targeted at the medical profession. Importantly, the bank also emphasizes cash management and deposit products, including merchant card, lockbox and check imaging. On the personal side, it offers a full array of deposit and loan products.

Affinity marketing also plays a key role in SunTrust’s medical marketing. The bank highlights a relation-ship with the Duval County (Florida) Medical Society’s “Physicians in Training” group, centering on meeting the needs of doctors in residency or new to a medical practice.

3.  Increase the effectiveness of the deposit sales effort
Despite the importance of deposits, business bankers at most banks continue to emphasize loan sales. Most bankers are better schooled in loans than deposits and have a long history in selling them.

While it is not necessarily easier to sell a loan than a deposit, the process may be more straightforward and shorter. Loan decisions often occur around the need for a specific piece of equipment or anticipated cash flow requirement. Deposits tend to remain where they are unless some significant event occurs such as, for example, operational mistakes, poor service or an attractive investment opportunity.

Creating a deposit-focused sales force places clear emphasis on this area and takes deposit sales out of the realm of the day-to-day to give it significant and specific emphasis. A deposit-only sales force (in effect, “hunters”) can concentrate with laser-like focus on this one initiative. At a minimum, piloting a deposit-only approach as a test makes sense for many banks struggling to maintain current deposit levels or improve their deposit mix.

Union Bank of California, a subsidiary of San Francisco-based UnionBanCal Corp., and Detroit-based Comerica Inc., among others, have formed deposit-only sales forces aimed at the small business segment. The rationale propelling these efforts includes the view that the traditional banker (both in the small business and middle market arenas) has been too focused on loans, oftentimes downplaying the potential of deposit and cash management opportunities.

Comerica, for example, fields deposit/cash management teams targeted at the majority of companies that are non-borrowers. The bank appears to have anticipated some lender concerns regarding deposit teams encroaching on what they have previously viewed as their own marketing turf by training cash management relationship managers (CMRMs) to recognize credit opportunities and to bring in a credit-focused relationship manager to manage those opportunities. Credit-related cross-sell goals are part of the overall metrics for Comerica CMRMs.

4.  Segment the market
The product packages offered by deposit sales forces at SunTrust and Comerica demonstrate how banks are segmenting their approach to deposit generation. Multiple approaches to segmentation exist and banks can select one or more initiatives that fit with their capabilities and aspirations (see chart “Picking the Right Segment”).

Many banks tend to segment by industry, developing product packages that can be altered slightly to meet the needs of a specific segment. San Francisco-based Wells Fargo & Co. Inc., for example, focuses on a number of industries within small business including accountants, contractors, retailers, restaurants and food services. While the bank offers substantially the same product set to customers across these industries, its product emphasis changes depending upon industry-specific needs. For contractors, Wells may emphasize equipment finance while merchant services and cash management products (not lending) will be the leading offer for retailers.

Deposit-rich industries merit a concentrated focus. This includes not-for-profits, property management, homeowner associations and professional services firms—all of which generate significant levels of deposits while requiring minimal lending.

Opportunities exist to segment by industry, product, distribution channel, and company size and lifecycle. Picking a segmentation scheme and developing an implementation plan around it increases the likelihood of the bank gaining traction with its chosen segment and avoiding the commoditization that increasingly impacts banks today.

5. Align incentives to highlight the importance of deposits
Banks often say that deposit growth is critical and that capturing deposits should have the highest emphasis. But is that the message conveyed by their compensation plans? Oftentimes, management may communicate that they want deposits while, at the same time, providing higher compensation for loan sales.

Recent conversations with line bankers underscore this incentive gap. “Our incentives under-weigh the value of deposits,” one said. Another commented, “Commercial bankers are not disincented to do deposits, but they are incented to do loans.” Simplistic, but true: unless bankers are paid to sell deposits, they will not devote their best efforts to that quest.