Why Should Bank Marketers Know and Care About Funds Transfer Pricing. A Q&A with @JeffMarsico

On Monday, September 23, 2013 Jeff Marsico and I unleashed our presentation and white paper “Product Profitability - Out of the Shadows" at the 2013 ABA Marketing Conference in San Antonio, Texas. In our presentation, the first part focused on "How is Product Profitability Made." Jeff and I are going to keep the conversation going by talking about one of the critical components of product profitability, Funds Transfer Pricing (FTP). We will share the why you need FTP, some challenges of using FTP and some recommended marketing and management uses of FTP data. The format of our dialog will be an interview format.

BACKGROUND

Question: Jeff, how long have you taught profitability at the ABA Bank Marketing school?

Answer: I’ve taught at the school since 2008. When I was first contacted to do it, I was a little surprised at the interest. It was the first step in the process of breaking my stereotype regarding bank marketers.

Why were you a “little surprised?”

I held the tried and true stereotypes of the differences between finance and strategy wonks (i.e. me), and marketing/creative types. But the school was dedicated to improving marketer’s ability to speak the language of the C-suite. And I applaud them for it.

Would you say that most of the students are shocked that they have to dust off their math skills?

I would say, that at least initially, I was the least popular instructor because my course could be taught in a spreadsheet versus a desktop publishing application.

Before you started teaching bank marketers, do you think you had your own set of biases as to what a marketer is?

Yes. I thought they ran the ad budget. Although true, it is a myopic version of the function. But if marketers were honest with themselves, I think they would admit they are more comfortable developing a business banking flyer than improving the profit trends of a business sweep account. When you are uncomfortable with the subject, that’s where growth begins. For both me and the students.

When these marketers start your course, what percentage of the class has ever heard of FTP? Know what FTP is?

Somewhere close to zero percent for those banks with less than $5 billion in assets. The larger banks have greater resources, both personnel and software, to deliver profitability information. And the marketing function has more specialists versus the generalists typically found in a community bank.

Wow! “Somewhere close to zero percent for those banks with less than $5 billion in assets” do not not know what FTP is? That assessment seems alien to me. My entire marketing career has always dealt with the math of profitability. My background is mostly non-banking. Do you think the financial services industry has typically devalued profitability in the marketing ranks?

I think profitability is devalued in all ranks because it is part art and part science. Sure we can calculate bank-level ROA, but do we drill down to the products that are most/least additive to ROA? Do we cross-reference to our customers and the products they use to identify profitable cross-selling opportunities? Profitability in community banks is starting to get some wind in its sails. But slowly.

WHY BANKS NEED FUNDS TRANSFER PRICING

Jeff, it has been my observation that many bankers look at deposits as an expense due interest paid customers on their deposit accounts and loans as income due to the interest collected on loans. Let’s get to the bottom of this misconception. So Jeff, what is Funds Transfer Pricing (FTP)?

You described the fundamental need for FTP. If you are a slugger for the NY Mets, provided they have a slugger, would it be fair that your performance bonus be based on the pitching staff’s ERA? No.

Therefore it’s not fair to credit the branch manager for how well the commercial lender performs. If you credit the branch manager the bank’s yield for the deposits they gather, you are effectively letting the commercial lenders’ performance impact the branch manager’s bonus.

In comes FTP, that isolates the performance of various contributors to the balance sheet. The branch manager receives a market rate credit for the deposits she gathers, and the commercial lender receives a market rate charge for the loans he makes.

Are there different types or methods of FTP?

Yes. The simplest FTP method being the single rate or pool method. Suppose your deposits have an average duration of 3.5 years. You then credit those deposit gatherers for a pool rate for a 3.5 year market instrument.

The best practice FTP method is matched maturity, or coterminous FTP. This transfer prices every instrument, at the account level, on the balance sheet for a market instrument of the same maturity. So if I’m a branch manager, and I book a 1-year 0.50% CD today, and a market rate such as an FHLB borrowing rate, for a 1-year instrument is 0.80%, then I book a 30 basis points spread for the life of that CD. Using this method, you isolate each instrument, and exclude interest rate risk from the equation.

What type of banks or credit unions do not need to have a FTP process?

Small banks and credit unions, perhaps under $300 million, that are not rapidly growing can effectively manage their institution using “top of the house” financials. But if the institution’s plan is to grow, they should consider implementing an accountability culture that delivers profitability information to business unit managers. If you want to measure performance at a granular level, then FTP is one of the tools to get you there.

MANAGEMENT CHALLENGE

Can the profitability of branches, business units, products, relationships, households, individual customers, etc. be calculated accurately without FTP?

Profitability information is part art, part science.

Can applying a bank’s cost of funds to the commercial loan portfolio be used to make decisions in that department? Probably, if it is consistently applied and the focus is on trend. But, as mentioned, you could be disguising performance issues in this department by using a superior low-cost deposit base in the measurement mix. Plus, what of the interest rate risk… i.e. borrowing short and lending long?

By not using FTP, you could be providing attaboys to your commercial team for the hard work your branches are doing, and the interest rate risk inherent in the balance sheet.

Jeff, you mention “disguising performance issues” and commercial lending team “attaboys.” Talk about that further. If the risks you mention are not being properly measured, what is the potential impact to a bank’s Return on Assets (ROA) and Return on Equity (ROE)?

Look no further than 2008 - 2011 where the trials and tribulations of the loan portfolio played out. Lenders were rewarded when they booked those loans in 2006 - 2007. If lenders were subject to profitability information, FTP that isolates their loan yields compared to a market rate, equity allocation based on risk of loan to calculate ROE (Risk Adjusted Return On Capital or RAROC), and a robust provision allocation based on Allowance for Loan and Lease Loss (ALLL) methodology, perhaps those loans would not have looked so good in 2006 - 2007.

TOP 3 STRATEGIC USES OF FTP DATA

What are the top three strategic capabilities a bank gains when they fully embrace the power of a FTP system into their financial DNA?

1) Pricing and operational discipline in day to day business development activities
2) Accountability at the business line level
3) A focus on the most profitable customer segments and not solely the ones with the highest balances.

Thank you Jeff. How would you like to summarize what you have shared?

Funds Transfer Pricing is one of the tools in an overall profitability reporting methodology. It does not stand alone. But those that use FTP, pushing institutional knowledge of precisely where their financial institution does and does not make money, and promotes an accountability culture for front-line employees to deliver profitable relationships and support staff to deliver efficient internal service to elevate profits at the account level, than how is this a bad thing? It’s not. But it is difficult to move from where you are to such an accountability culture. Bankers have to ask themselves, “is it worth the journey?”


SUMMARY

Funds Transfer Pricing is a necessity for banks today. Size does not matter anymore. Every area of the bank needs to understand the basics of how a bank makes money from each dollar of a deposit and a loan. For today’s relationship managers and branch managers, profitability can no longer be “devalued.” The same goes for commercial lenders.

It is great that Jeff teaches profitability at the ABA Bank Marketing school. Marketers need to embrace the power of profitability and the power they wield in improving the bottom line of banks. Marketing should no longer be considered an expense but rather an investment in improving the value of a bank. Jeff put it best when he said “Profitability in community banks is starting to get some wind in its sails. But slowly.”

If you want to know more about how bank profitability is made and learn more about strategic marketing uses of this information, download and read the white paper that Jeff Marsico and I authored, “Product Profitability - Out of the Shadows”.

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Finally got the @PayWithIsis latest update on my @VerizonWireless @Motorola Moto X

Over the last few months I have been tweeting about mobile wallets

and getting my Motorola Moto X smartphone prepped for the national rollout of the PayWithIsis mobile/digital wallet. 

My phone has a secure sim so it was compatible with the PayWithIsis app and I installed the older version and configured the app. At the time I did not have a compatible credit card to use. The Google Wallet app works on my phone but not as a tap and pay device.

When Google released their latest Android operating system, Kit Kat, everything changed. This new version has built in support for a technology called Host Card Emulation (HCE) which allows a program, like Google Wallet, to emulate a card and communicate directly to a NFC enabled point of sale card reader. My phone was updated quickly and soon after the release, the Google Wallet app

was updated and I was able to use the tap and pay functionality. Since I have been in the Google smartphone ecosystem for a few years, the debit cards I typically use were already configured in my digital wallet. Making payments at NFC enabled point of sale devices has been easy.

The PayWithIsis app was released nationally and my phone was not included. Some speculated that PayWithIsis shut out phones that could use HCE. Well that is not true. Tonight (December 18, 2013) I received my Verizon PayWithIsis update. 

The new feature was compatibility with Android KitKat. After my app upgraded and I accepted the new user agreement (which was emailed to me for my records) I was greeted with this preferences menu over the login PIN. 


I had to set PayWithIsis as the default wallet. I initially selected no and was dumped out of the app. I went back in and changed the default.

The card selection menu was updated to include WellsFargo.

Since I do not have a compatible card I selected “Other card” and was presented with an offer to enroll with the American Express Serve pre-paid account and connect any of my cards or bank accounts. The nice touch was the $50.

The PayWithIsis app has a “Where to Pay” finder in the app.


It then launches the phones web browser

and produces a map. There are places on the map to use it. For me it is dominated by McDonald’s, CVS and RiteAid.

After exploring the PayWithIsis app I launched the Google Wallet app and was asked to change my wallet preference. I expected this.

I selected “No” and the Google Wallet app completed to open up. The main Google Wallet dashboard prominately displayed the fact that “Tap and pay will not work.”

I liked the fact that the Google Wallet app has a main dashboard option to switch the default back to itself.

Now I get to spend the next few weeks testing each of these mobile wallets in real world scenarios.

How the “Bar Rescue: Bankers Edition” blog post from @JeffMarsico started

My friend @JeffMarsico released a blog post yesterday called: 

Bar Rescue: Bankers Edition. After we wrapped up writing our white paper on bank product profitability I started thinking about one of my favorite reality shows on TV, Bar Rescue, and how one of the focuses is on financial management. Well I wrote the piece below and shared it with him. This short note led to his blog post that I strongly suggest you read.

Spike TV has a reality show called Bar Rescue. The host, Jon Taffer,

rescues a bar that has requested the shows help. Jon Taffer is an internationally recognized, award-winning restaurant operator, owner and concept developer. The opening credits mention 6,500 bars will go out of business this year. One of the first questions Jon Taffer asks the financially underwater bar owners is what is your liquor cost. What is liquor cost? It is a bar financial ratio designed to help measure the health of liquor sales. This is the formula:

Liquor cost =

(Start of period liquor inventory value - end of period liquor inventory value + value of purchases during period) / Liquor Sales during the period

I have yet to see an episode where a bar owner knows their liquor cost. Banking is different. Banks must publish financial information in a standard format to the government quarterly. What that means for banks is they always know their liquor cost. Any business that sells a product or service should have a process to calculate product profitability.

That is it for my note to Jeff. On Monday, September 23, 2013 at 11 a.m. in San Antonio, TX, @JeffMarsico and I will be speaking on bank product profitability. The title of our presentation at the ABA Marketing Conference is “Product Profitability - Out of the Shadows”. If you are going to the conference, Jeff and I would love to see you there.

@dmgerbino

Thank You Ethan Marcotte for @RWD

Today, May 25, 2013, is the three year anniversary of the seminal A List Apart article “Responsive Web Design” by Ethan Marcotte. image

 In honor of its three year anniversary, it should be read again. If you never heard of this web technique. Shame on you. Go read it now! When you are done go to the Media Queries web site where you can see screen shots and links to several hundred websites using the Responsive Web Design (RWD) methodology. You will see links to Time, British Vogue, Modern Green Home, and Microsoft.

Ethan closes his article with: “Responsive web design offers us a way forward, finally allowing us to “design for the ebb and flow of things.””

That was 2010. The devices we use today has changed dramatically. The rate of change away from the desktop to mobile devices has increased faster than anyone thought back in 2010. This old internet technology is still delivering an excellent web experience today. RWD is more important than ever. 

Thank you Ethan for Responsive Web Design, the article and the book.image

Don’t forget to follow Ethan’s Responsive Web Design Twitter @RWD

“American Banker” names Square’s Jack Dorsey Innovator of the Year, praises impact on payments space

I read on The Next Web the following story: “American Banker” names Square’s Jack Dorsey Innovator of the Year, praises impact on payments space. It is a great article and Jack’s story is a great one. I am disappointed in American Banker. Mr. Dorsey did not create the mobile payments industry. He does not have the the most sophisticated or most innovative solution. So why does he get the innovator of the year? I think it is because he is the most popular individual in the space and that is primarily due to is creation of Twitter. Don’t get me wrong. He is deserving. I just think American Banker team should have made this award to the segment of the payments industry that Jack Dorsey is a member of.

I also read the Amercian Banker article authored by Maria Aspan and it is very well written. [disclaimer: I have met Maria in person and hung out with her at at least one NYPAY event]

I was unable to post a comment on TNW site. I had planned on posting the following:

"Jack was not first to market. His success in the payments space has a lot to do with his success at Twitter. I find his POS and wallet solution innovative. His payment dongle not so much. His peers in the payments space are all innovative. American Banker should have honored them all.

Many know Jack’s inspiration was in 2009. In a Fastcompany article - “McKelvey explained this problem to his friend Dorsey, who is a natural tinkerer, and the pair decided to investigate how the merchant credit card accounting process worked. It didn’t take them long to discover that there was indeed a way for McKelvey, and everyone else, to begin accepting credit cards without having to pay exorbitant fees. All it required was cutting out the middle-man, which the Internet is famously good at, and bringing the card swiping process into the mobile phone era.”

Many do not know ROAM Data, Inc. was founded in 2005. The following is from their LinkedIn page - Founded in 2005, ROAM is a pioneer in the MPOS space, having produced and distributed the industry’s first secure card reader; today ROAM powers mobile point of sale solutions for many of the leading players in this space, globally.”

I wonder if the two of them found ROAM Data when they were searching for a solution? I would have thought they would have found PayPal. There was no reason why Mr. McKelvey could not have his own merchant account at that time. The good news is he did not go with the status quo, he instead went to a buddy and they did their own thing.

I first found out about ROAM Data from the Verizon Get It Now app store. The feature phone I had at the time was the LG Dare. I got this phone as soon as it was available online in June 2008. It was sometime after that I found this ROAM Data app that allowed you to manually enter credit/debit card numbers into your merchant account via your cell phone. I thought that was great. The use cases I was thinking of in my head very similar to Mr. McKelvey’s use case.

There are many other innovative companies out there in the mobile payments space. I did some bug hunts with the card.io app on my Motorola Droid X2 smartphone before they were acquired by PayPal and my current favorite is LevelUp. Never heard of LevelUp? They are the payments company that did away with charging merchants the interchange fee. The language on their site is very well written: “LevelUp’s Interchange Zero™ payment network is a mission to eliminate payment processing fees forever. We charge 0% for all payment processing. We also provide the LevelUp Hardware free of charge. When a customer pays you $10, you get $10. Simple. It’s not just a business model, it’s a mission. We believe that moving money should be free.” How do you not choose them first?

These are just a small sampling of the mobile payments innovation out there. Jack is the most popular kid in the class but my no means the most innovative. The American Banker magazine should have known better. They should have recognized the leaders in the segment and not just the “big man on campus”.

@dmgerbino

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