Loan Pricing Tools for Raising Deposits
Talk about an under-appreciated tool. Loan pricing apps are capable of inspiring a bank toward any number of strategies beyond setting decent loan rates: growing profit; improving credit risk management; encouraging fee income; migrating away from expensive products; and growing deposits! However, most banks don’t use loan pricing apps. Typically, they get thrown out after the no-win epic battle between Finance (which thinks lenders are loose with rates) and Commercial (which thinks Finance is meddling).
Let’s consider this common problem in the post-recession economy: the bank is bringing in lots of new healthy commercial loans, but is struggling to find the deposits to fund them, especially as liquidity and wholesale funding are viewed as toxic by regulators. So, many CEOs simply set higher deposit goals, delivered to all levels with lots of podium pounding.
This strategy will likely deliver the same results as always: the staff will be engaged only until the next hot strategic issue rolls in. And CEOs have to attend to that new hot issue because it’s their job. Yet, they still need a strategy for deposits that will keep working after they’re off to the next issue. That will only happen when this seemingly impossible thing happens: the lender and the actual customer both work together to increase deposits for the bank.
So, think of loan pricing as a deposit strategy. In order to do so, consider two steps. First, create or buy a tool that has all the right components (see list below), making sure it includes deposit value contribution. Second, empower commercial lenders to aim for a “relationship spread,” not just the loan rate, which is something only the CEO can dictate. Relationship spread includes the value of loans, deposits, fee income and the profit or loss generated by those products.
How will lenders view this? Not as meddling, but as an opportunity. Suddenly deposits transform from a distraction that requires cash management that the lender doesn’t always feel comfortable selling to a way to win the deal. Nothing excites a lender like making a loan. What tips it even more is if the officer uses the model in front of the borrower to encourage them to bid down the loan rate by adding more deposits. Yes, it’s hard to break old “black box” habits of keeping bank data hidden, but this is a new transparent era.
Transparency engages customers, who feel respected. And the bank CEO now has the most powerful deposit generating force of all – the actual business customers, digging into their pockets to find every deposit penny so they get that iconic loan rate down. The customer might even accept a cross-sell offer just because it makes their rate better. This helps the business customer’s bottom line and offers them highly coveted bragging rights, which creates buzz and brings in more customers. All of this good sense marketing also delivers the ultimate goal of more deposits.
Finance will get on board too. They own the calculations. They set the hurdle rate, or the minimum total spread for the relationship. They get juicy stats for Board reports. They get their margin control, their risk management check and even a way to get more cross sell. Most of all, they’ll get funding. Why, even regulators will like the clear approach to a typically foggy concept, and you know how they love data.
The CEO, however, needs to be the one making it all happen. If Finance, Commercial, or Information Technology drives the effort, the results can easily get bogged down in dogma and details, some of it with no direct link to the strategy of raising deposits. The CEO’s involvement might be only an occasional peek into the project team working sessions to add the two most powerful words in his arsenal: “Move on.”
And here’s a list of suggested elements for the loan pricing tool:
- Loan net spread: A funds transfer cost based on loan duration, loan structure impacts (amortization, bullets, rate sensitivity, prepayment penalty), cost of risk based on risk rating and industry, loan fee treatment and corporate overhead allocation – although the last item can be left out without hurting the integrity of the model.
- Deposit net spread: A funds value for deposits based on deposit duration using a market term structure of rates, deposit product costs and fees based on estimate of transactions, handling of “analyzed” deposits and a way to check if the deposits promised actually come in. There should be a limit to the amount of benefit from deposits so loan rates don’t go below a deep minimum.
- Other: Cross-sold product profit or loss contributions; overhead, unless you go purely “incremental”; relationship spread calculation; and a good summary report for the loan package with hurdle rate comparisons.