Realizing Profitable Relationships

Certain uncertainty

According to a Reuters article from April 2024, “The uncertain trajectory of interest rates is making it hard for U.S. banks to forecast profits and leading some to adopt a cautious stance for the remainder of the year.”

This uncertainty is very likely to continue in 2025, with a Deloitte report observing, “Bank executives will be welcoming 2025 with mixed emotions, unsure how the year will unfold and reshape banks’ fortunes. While inflationary pressures have subsided and interest rates are dropping, sub-par economic growth, continuing geopolitical shocks, and regulatory uncertainty will give bank CEOs anxiety.”

Bank sales staff must continue forging ahead in these uncertain times, competing for loans with clients seeking optimal rates. Offering highly favorable loan rates to attract new relationships requires a disciplined profitability analysis to ensure healthy growth that supports a strong risk-adjusted rate of return without negatively impacting margins.

Holistic analysis of customer relationships

Now is an excellent time for bank leaders to proactively consider new pricing strategies to future-proof their institutions and better navigate market fluctuations.

By shifting toward providing comprehensive profit analysis and cultivating stronger client relationships, banks can establish a robust foundation capable of enduring ongoing market volatility and external factors beyond their control.

Now more than ever, bank executives must understand exactly which areas of their business are performing well, which are underperforming, and what it will take to mitigate shortfalls.

The value of genuine insight

While bankers intuitively believe they understand who their most profitable customers are, genuine insight requires looking past hunches to uncover a holistic view of every current and potential relationship. Obtaining that insight is where advanced customer profitability modeling can prove invaluable, providing a toolkit to cut through the noise and optimize the portfolio.

A recent article in the Financial Brand identifies the following steps as essential for establishing a comprehensive profitability analysis framework within banks:

• Audit available data: Compile sources of customer insights across your organization to assess potential model inputs. Identify any gaps requiring additional data integration.
• Build predictive models: Leverage statistical modeling techniques to analyze how customer attributes correlate with profitability. Regression, decision trees, and clustering algorithms provide predictive power.
• Generate customer lifetime value scores: Apply models to your customer base to quantify anticipated lifetime value based on profile attributes and product holdings.
• Identify opportunities: Profitability scores spotlight engagement opportunities such as cross-sell potential. Lower scores initiate an examination of underlying causes.
• Enable human conversations: Arm bankers with profitability insights to have productive conversations grounded in a data-driven understanding of customer needs.
• Guide strategy with data: Incorporate profitability metrics into acquisition targeting, onboarding, pricing policies, and engagement prioritization.
• Iterate: Continuously enhance model accuracy by validating predictions against emerging results and refining algorithms. Profitability modeling, much like other complex tasks, requires iterative processes and continuous refinement through trial and error.

What profitability analysis should encompass

Profitability analysis should enable a pricing model for a single account or an entire relationship. Banks should be able to construct pricing scenarios for both existing and potential account holders. Analysts should be able to manipulate key elements (such as balance and rate) to consider the future opening of accounts and any balance changes that may occur.

Careful preparation and consideration of the primary factors of profitability in an analysis preparation puts valuable, actionable insight into the hands of an institution’s decision makers.

The payoff is in the reporting

Once profitability analysis parameters are set, flexible and immediate reports should deliver a broad view of findings for bank executives to act upon. Reports should cover areas such as:

• Profit by decile: displays households according to how profitable they are.
• Profit by portfolio: displays the profitability of the account in each employee portfolio.
• Profit by group: displays account holders’ profitability by dividing them into customizable ranking categories (bronze, silver, gold, diamond, etc.).
• Profit by location: displays current and average profit for each branch location.
• Product profit and loss: displays the number of accounts, the balance statistics, and the profit level for each product offered.

For many years, advanced modeling techniques were accessible exclusively to large banking institutions, thereby excluding smaller entities that lacked the necessary technical expertise and resources; however, financial technology advances have democratized access to analytics, allowing community banks and credit unions to leverage next-generation platforms.

This provides a clear pathway to clarify customer value and transform profitability management.