In this flat-rate environment, financial institutions must look past net interest margin as their primary driver of income and seek other sources to drive profitability.
The key, of course, is knowing what other sources to turn to and how to leverage them effectively. So let’s dive in to the two big areas you should review:
1. Loan pricing
Because we’re in a low-rate environment, looking at your loan pricing, managing on how long to lock rate terms, and determining when to meet competitor rates should become top priorities for your team.
Different institutions take different stances on pricing. Maybe you’ve historically been a low-price leader and have used that strategy to gain market share. Maybe you’ve defaulted to pricing peer instead of to risk. Whatever the case, your loan strategy pricing is now more critical than ever. And you’ll need to move quickly to shed traditional pricing attitudes if you hope to capture the opportunities presented by the new economic environment.
Key questions to consider: Do you know how pricing is determined by your team currently? What are all the different types of lending your financial institution does? Is your pricing done on an ad-hoc basis, or do you have a strategy that defines what types of lending you can be competitive on and what types you cannot or do not want to be?
How to build a comprehensive loan pricing framework
When building a comprehensive loan pricing model, there are six things we’ve found are key to the highest-performing financial institutions:
- Align pricing strategy with overall business strategy: Understand what type of lending your institution does, why it does those types and where are the best margins.
- Govern the pricing function: Have robust discussions with your senior team around how pricing occurs within your institution, who’s making the pricing decisions and what modeling is in effect to govern the pricing function.
- Establish differentiated pricing for different lending lines of business: In our analysis of portfolios, we’ve found that the clients who see the best returns have established differentiated pricing for the different types of lending they do. They understand their core business model. Ask yourself, where are you willing to price to market and where are you not? What is your risk differential? When are you willing to walk away from a deal because the pricing doesn’t meet the standards you’ve established for your return metrics?
- Commit to risk-adjusted pricing for credit extensions: Educate your team about why you’re doing risk-adjusted pricing. What is the basis-point differential you can articulate to each team member, and can you correlate that to the risk you’ve taken on that type of credit extension or lending?
- Track pricing performance using multiple metrics: Once you’ve established how you’ll price, and once you understand the pricing for each particular lending you do, determine how will you perform tracking to ensure that performance is actually happening.
- Identify price leakages and quickly correct them: Once you have performance metrics in place, identify the places pricing is inappropriate and why. Then make corrections.
With these six keys in mind, talk with your CFO, Chief Lending Officer and other senior leaders about what loan pricing framework you can develop to get you through this low-rate environment. Then, teach your team the loan pricing framework, monitor the results and govern the function.
2. Non-interest income
Now is the time that you must increase the percentage of total income derived from non-lending activities, it’s time to look at your institution and identify how to change your mix.
Here’s where education is critical. Sometimes front-line staff don’t understand the importance of fee income. But if a CSR has this education, they’re less likely to waive a transaction fee that’s perfectly appropriate to charge. So make sure your employees know the importance of services charges, ATM fees, income from the sale of cashier checks, safe deposit fees, wire transfer fees, card charges, etc. to the financial institution’s overall financial health. Fee income is not a bad thing. You’re providing meaningful services like fraud protection, check clearing and cash — all of which cost money to run. Your customers are willing to pay for these valuable services when they are appropriately framed by your service team.
Methodology is also crucial. And developing that methodology comes from understanding the value of your services. What you do you consider key fee income and where is it coming from? Are you a consumer driven model? Commercial driven? Are your fees majority deposit-related, or do they come from alternative investments, insurance or mortgage origination?
In building your methodology, look at the “who” of everything. Understand who your customers are and what their customer journey looks like (so you can identify points of contact to leverage fee income), who on your team produces fee income (so they can understand the impact they have on income levels), who should be responsible for measuring fee income and forward-looking metrics (so they can identify when you have a particular fee in a particular client experience and why), and who will drive results (so they have accountability for turning measurements into action).
One you have developed your pricing methodology, communicating it is your next step. Let employees know information like what services cost money and how much, and what your profit margin goals are. Then, make sure the methodology is applied consistently, and identify when it’s not working so you can make corrections. You must measure its effectiveness, including identifying price leakages and correcting them.
Evaluate your systems to ensure you’re properly capturing fees
Technology is here to make your life easier, and your core systems can help you ensure your capturing appropriate fees. Pay special attention to these three systems:
Core deposit system: With your core deposit system, specifically focus on retail fees. But understand that it’s up to your financial institution’s leaders to make sure the core deposit system captures fees appropriately. Understand how it works, when it charges fees and why, and whether it operates optimally to capture all retail fees.
Account analysis system: Your account analysis system is the backbone of a commercial checking account program. If you don’t have one, talk to core provider about getting one. If you do, who is the expert on the system within your organization? How do operations and service line teams look at and understand the system? Is it waiving and charging fees properly? How many pricing overrides are there? In this low-rate environment, you don’t have the luxury of assuming everything works.
CRM or profitability system: If you’ve implemented one, are you using it? If you’re using a pricing system for loans, does the profitability system measure into that? How do you use it to make the most effective pricing decisions?
The impact of real time payments
Trends are just as important to pay attention to as technology. There’s been a market shift during the COVID-19 pandemic in terms of providers and payment aggregators, as well as evolving customer expectations on the velocity of payments.
Everyone wants their money faster and more often. Everyone wants real-time payments. The good news is, real-time payments can be a source of fee income. Depending on your customer journey, you must decide things like whether you’ll offer free real-time payments to consumers but charge businesses to originate them, and whether you’ll charge businesses for the receipt or processing of real-time payments.
Get the assistance you need
If you’ve been overly reliant on your core processor to provide solutions and sources of fee income, now is the time to review third party options. Where is the opportunity for enhanced fee income? It is also the time to determine who is the chief fee income officer for your financial institution. The role is laser-focused on implementing, measuring and capturing the income needed for true financial performance. The individual tasked as chief fee income officer should understand where the industry is going, where there are opportunities for fee income you haven’t thought of (from mortgage origination to RIAs and insurance) and what other providers can offer assistance.
Wipfli is also here to help. We have strategic planning specialists who can help your financial institution dive into the liability side of your balance sheet and leverage ALM to become more profitable. Contact us to learn more or get started.
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