Incentives for business customer profitability

Many bank CEOs find strategic plan execution more difficult to manage than strategic plan setting. The reason is that CEOs can control every aspect of a strategic planning session but not every step of implementation.

The problem is that the minutia of daily bank life creeps in and dominates the time of employees, who are ultimately the ones who deliver plan results. The push from long-term strategic plans, even with the CEO behind it, just isn’t strong enough in a given moment on a given day to win out against the rush of other demands on time. Execution loses the war because it loses so many little battles.

CEOs need to improve execution results, not by pushing harder from the top, but by creating incentives right down to the moment-by-moment level of the people on the front lines. Below are six examples of how this can work with business customer profitability systems:

Credit risk management. Your profitability system will clearly have a “credit risk factor” tied to risk rating. If you graph your typical credit cost to risk rating schema, it will rise exponentially. A “1” or “Excellent” credit might get clipped only five basis points (bps). A “4” or Acceptable might have a cost of 50 bps. But from there, up to “8” doubtful, it rises quickly and can reach 50% or more (5,000 bps).

This attaches a whole new meaning to “downgrade” of a credit as profitability drops like a stone. Even a “4” to a “5” downgrade, depending on Risk Management’s cost grid, could mean an additional 50 to 100 bps of cost on that loan, which will severely impact profitability. One customer downgrade can wipe out an officer’s ability to earn incentive. This lights a bonfire under his or her seat, leading to quick efforts to shore up collateral, negotiate terms, or even work to exit the customer. This will happen in real time, with the officer, not Risk Management’s hammer, providing the nudge.

Distributed data integrity management. One of the worst days in the life of a new data-based system is the day when you realize your data is not as clean as all those pretty slides the product sales people showed you. The “scrubbing” work can be horrific and take months, even years, if run by a small group of finance people. However, by tying the results to officer incentive, every one of those officers will be combing over their data for accuracy and will immediately bring data integrity issues to the table.

Growing deposits. I’ve written previously about how loan pricing tools can help grow deposits. Business profitability systems can grow deposits too. Assuming business deposits generate profit per-dollar (this has been difficult over the last eight years), then for every dollar the officer can convince a customer to move to the bank, the officer’s total profitability will rise. So will their incentive. If bankers feel the current rate environment doesn’t capture the value deposits have to liquidity and funding, they can increase the profit contribution of deposits. This will lead to more pressure to add deposits, with an incentive in it for the officer.

Prepayment penalties are not a favorite of loan officers, and most would probably rather leave them off for competitive reasons. Yet, they are critical to hedging payoffs. Finance can back into the value of a prepayment penalty by pricing the underlying put option being given to the customer. If that cost is factored into any loan without a prepayment penalty, and is absent from those with a prepayment penalty, then these will start magically appearing more often.

Fee-generating cross sell efforts. No need to say more than this; if a loan fee or a fee for a cash management service or any other service ties to the profitability, and then to incentive, you’ll get a whole new appreciation for them.

Customer engagement. Last but not least, an officer tied to everything the customer does in a real way will become more engaged with that customer. These employees will talk more about strategic issues that can grow the customer because that comes back in profit.

Mr. Blackall is practice director at Phoenix, Ariz.-based CCG Catalyst, a bank consulting firm providing strategic direction and focused guidance. He can be reached at [email protected].