Think in Basis Points

Empowering Community Bank Employees to Drive Profitability

By: Benjamin Crowley, Managing Director

Community banks play a vital role in the economic health of local communities. Their success hinges not only on strategic leadership but also on the collective understanding and contribution of every employee. A significant challenge, however, is that many bank employees, even those in leadership positions, often lack a clear understanding of how their daily actions impact the bank’s overall profitability. They may not fully grasp the levers they can pull to improve the bottom line. This article argues that educating community bank employees to “think in basis points” can be a powerful catalyst for change, fostering a culture of financial awareness and driving cumulative improvements in Return on Assets (ROA).

The Power of Basis Points

At its core, “thinking in basis points” means understanding the direct correlation between specific actions and their impact on the bank’s ROA. ROA, a key indicator of profitability, measures how effectively a bank is using its assets to generate earnings. For a $1 billion community bank with an ROA of 1%, the math is straightforward:

• 1% ROA = $10 million in profit
• Therefore, each basis point (0.01%) of ROA change = $100,000 in profit (or loss)

This simple calculation transforms abstract financial concepts into tangible, relatable figures. Instead of being disconnected from the bank’s financial performance, employees can directly see how their actions contribute to, or detract from, the bottom line.

Three Levers for ROA Improvement

Banks primarily improve their ROA through three key avenues: growth, efficiency and expense discipline, and pricing discipline. Each of these levers requires careful consideration and strategic execution to maximize its impact on the bottom line.

1. Growth: This involves increasing the bank’s asset base through loan origination, deposit acquisition, and strategic investments. Growth is often seen as the most direct path to higher profitability, but it must be managed carefully to avoid excessive risk and maintain asset quality. Most strategic planning clients choose growth to increase net interest income, and to drive down expense and efficiency ratios.
   • Loan Origination: Expanding the loan portfolio is a primary driver of asset growth. This can be achieved through various strategies, such as targeting new customer segments, developing specialized loan products, or expanding into new geographic markets. However, it’s crucial to maintain sound underwriting standards and avoid relaxing credit criteria in the pursuit of growth. A focus on high-quality loans with appropriate risk-adjusted returns is essential. To create a culture of balance between risk and return, we recommend minimizing exceptions to policy and allocating capital per loan based on risk of the loan and setting ROE hurdles so that the bank gets paid for making riskier loans.
   • Deposit Acquisition: Attracting new deposits is another key component of asset growth. This can be accomplished through competitive interest rates, innovative deposit products, and superior customer service. Building strong relationships with local businesses and community organizations can also be an effective way to attract deposits. Managing the cost of funds is critical; the bank must balance the need to attract deposits with the need to maintain a healthy net interest margin. We recommend holding deposit gatherers accountable for the overall spreads from their deposit customers.
   • Strategic Investments: Investing in new technologies, infrastructure, or business lines can also drive asset growth. For example, a bank might invest in a new mobile banking platform to attract younger customers or acquire a wealth management firm to expand its service offerings. These investments should be carefully evaluated to ensure they align with the bank’s overall strategic goals and offer a reasonable return on investment. Strategic investments can be measured for effectiveness. For example, if a bank invests in a robust collection system, and this investment drives the operating expense of the Loan Servicing Department from 22 basis points of the loan portfolio to 24 basis points, fine. So long as the investment results in Loan Servicing operating expenses as a percentage of the loan portfolio dropping below 22 basis points within a reasonable timeframe, as agreed upon at the time of investment.

Ultimately, sustainable growth requires a balanced approach that prioritizes both sides of the balance sheet.

2. Efficiency/Process Improvement: Streamlining operations, automating tasks, and reducing waste can significantly lower operating expenses, thereby boosting ROA. Building a culture of continuous improvement can have a direct and immediate impact on the bottom line, making process improvements a critical focus for community banks.
   • Process Automation: Automating manual tasks can significantly reduce labor costs and improve efficiency. This can involve implementing new software systems, such as robotic process automation (RPA), or streamlining existing workflows. For example, automating loan processing, account opening, or customer service inquiries can free up employees to focus on more value-added activities.
   • Technology Optimization: Leveraging technology to improve efficiency is essential. This can involve implementing cloud-based solutions, upgrading outdated systems, or developing mobile apps for customers and employees. The goal is to use technology to streamline operations, reduce costs, and improve the customer experience.
   • Waste Reduction: Identifying and eliminating waste is another key component of efficiency improvement. This can involve reducing paper consumption, optimizing energy usage, or streamlining supply chain management. Small changes can add up to significant cost savings over time.
   • Lean Principles: Applying lean principles to banking operations can help identify and eliminate inefficiencies. This involves analyzing processes, identifying bottlenecks, and implementing solutions to streamline workflows. Lean principles can be applied to a wide range of banking activities, from loan processing to customer service.

By focusing on efficiency and process improvement, banks can significantly reduce their operating expenses and improve their ROA.

3. Pricing Discipline: Optimizing interest rates on loans and deposits to maximize net interest margin (NIM) is crucial. This requires a deep understanding of product profitability, market dynamics, competitive pressures, and the bank’s risk appetite.
   • Loan Pricing: Setting appropriate interest rates on loans is essential for maximizing profitability. This involves considering factors such as the borrower’s creditworthiness, the loan’s risk profile, and prevailing market rates. Banks should use data analytics to identify optimal pricing strategies and avoid underpricing or overpricing loans.
   • Deposit Pricing: Managing the interest rates paid on deposits is equally important. Banks must balance the need to attract deposits with the need to maintain a healthy NIM. This involves monitoring competitor rates, analyzing customer behavior, and adjusting deposit rates accordingly.
   • Net Interest Margin (NIM) Management: NIM is the difference between the interest income a bank earns on its assets (primarily loans) and the interest expense it pays on its liabilities (primarily deposits). Optimizing NIM requires a holistic approach that considers both loan and deposit pricing. Banks should use sophisticated modeling techniques to forecast NIM under different scenarios and adjust their pricing strategies accordingly.
   • Understanding Market Dynamics: Pricing decisions must be informed by a deep understanding of market dynamics. This involves monitoring economic trends, tracking competitor behavior, and analyzing customer preferences. Banks should be prepared to adjust their pricing strategies quickly in response to changing market conditions.

Maintaining pricing discipline is essential for maximizing NIM and driving sustainable profitability. However, it’s important to balance pricing considerations with the need to maintain strong customer relationships and avoid alienating valuable clients.

Empowering Employees Through Financial Literacy

The key to unlocking the potential of these three levers lies in educating employees at all levels to think in terms of basis points. When employees understand how their daily actions impact the bank’s ROA, they become more engaged, motivated, and accountable. Consider these examples:

• Loan Officers: Instead of simply focusing on loan volume, loan officers should be trained to understand the ROA impact of different loan types, interest rates, and risk profiles. A loan officer who understands that a 0.25% increase in the average loan rate translates to a 25 basis point improvement in pre-tax ROA (or $2.5 million for a $1 billion bank) is more likely to prioritize profitable lending opportunities.
  • Understanding ROA Impact: Loan officers should be trained to understand how different loan characteristics affect the bank’s ROA. This includes factors such as interest rates, loan terms, fees, and the borrower’s creditworthiness.
  • Prioritizing Profitable Lending Opportunities: By understanding the ROA impact of different loans, loan officers can prioritize lending opportunities that offer the highest potential returns for the bank. This might involve focusing on specific loan types, targeting certain customer segments, or negotiating more favorable loan terms.
  • Negotiating Favorable Loan Terms: Loan officers should be empowered to negotiate loan terms that are both attractive to borrowers and profitable for the bank. This might involve adjusting interest rates, fees, or repayment schedules to optimize the loan’s ROA impact.
  • Managing Risk: Loan officers should also be trained to assess and manage the risks associated with different loans. This includes evaluating the borrower’s creditworthiness, assessing the value of collateral, and monitoring loan performance.
  • Example Scenario: A loan officer is presented with two loan applications: one for a $1 million commercial real estate loan with a 5% interest rate and another for a $500,000 small business loan with a 6% interest rate. By understanding the ROA impact of each loan, the loan officer can determine which loan is more profitable for the bank, even though the commercial real estate loan is larger. They should also consider the risk profile of each borrower and the cross-sell potential.
    
    
• Branch Managers: Branch managers can focus on deposit growth strategies that optimize the bank’s cost of funds. Understanding that reducing the average interest rate paid on deposits by 0.10% (10 basis points) can improve pre-tax ROA by 10 basis points (or $1 million) can drive targeted deposit campaigns.
  • Optimizing the Cost of Funds: Branch managers should be trained to understand how different deposit products and interest rates affect the bank’s cost of funds. This includes factors such as the interest rates paid on different types of deposit accounts, the fees charged for deposit services, and the cost of attracting and retaining depositors.
  • Driving Targeted Deposit Campaigns: By understanding the ROA impact of different deposit strategies, branch managers can design and implement targeted deposit campaigns that attract new deposits while minimizing the bank’s cost of funds. This might involve offering promotional interest rates on certain types of deposit accounts, targeting specific customer segments, or partnering with local businesses to attract deposits.
  • Managing Deposit Product Mix: Branch managers should also be responsible for managing the mix of deposit products offered at their branch. This involves ensuring that the branch offers a range of deposit products that meet the needs of different customers while also optimizing the bank’s cost of funds.
  • Monitoring Competitor Rates: Branch managers should regularly monitor the interest rates offered by competitors on deposit accounts and adjust their own rates accordingly to remain competitive.
  • Example Scenario: A branch manager notices that a competitor is offering a higher interest rate on money market accounts. To attract new deposits, the branch manager recoommends a promotional campaign offering a slightly higher interest rate on money market accounts for a limited time. The branch manager carefully analyzes the potential ROA impact of this campaign prior to recommendation to ensure that it will be profitable for the bank.
    
    
• Operations Staff: Operations staff can identify and implement process improvements that reduce operational costs. If a new software system can automate a previously manual task, saving the bank $50,000 per year, that’s a 0.5 basis point improvement in pre-tax ROA.
  • Identifying Process Improvements: Operations staff should be trained to identify opportunities to streamline processes, eliminate waste, and reduce operational costs. This might involve analyzing workflows, identifying bottlenecks, and implementing new technologies or procedures.
  • Implementing Process Improvements: Once process improvements have been identified, operations staff should be responsible for implementing them effectively. This might involve training employees on new procedures, implementing new software systems, or redesigning workflows.
  • Measuring the Impact of Process Improvements: Operations staff should also be responsible for measuring the impact of process improvements on the bank’s ROA. This involves tracking key performance indicators (KPIs) such as processing times, error rates, and cost savings.
  • Collaborating with Other Departments: Operations staff should collaborate with other departments to identify and implement process improvements that benefit the entire bank. This might involve working with the IT department to implement new software systems or with the marketing department to streamline customer onboarding processes.
  • Example Scenario: An operations manager notices that the loan processing time is significantly longer than the industry average. After analyzing the loan processing workflow, the operations manager identifies several bottlenecks and inefficiencies. The operations manager then implements a new automated underwriting system that streamlines the loan approval process and reduces the average loan processing time by 20%. This results in significant cost savings for the bank and improves the customer experience.

By empowering employees through financial literacy and a “think in basis points” approach, community banks can unlock their full potential and achieve sustainable profitability.

By understanding the ROA impact of their actions, employees become more engaged, motivated, and accountable. They are empowered to make informed decisions that contribute directly to the bank’s financial success.

Speaking the Language of Value

Beyond understanding the numbers, it’s equally important to communicate in terms of basis points. When employees and leadership speak the same language of value, it fosters a shared understanding and alignment of goals.

For example, consider a proposal for a new loan origination system (LOS) costing $500,000. Instead of simply presenting the cost, the proposal should frame it in terms of its ROA impact:

• “$500,000 investment = 5 basis points of pre-tax ROA”

The proposal should then clearly outline the efficiency gains and revenue enhancements expected from the new LOS, quantifying their impact on ROA. For instance:

• “The new LOS will reduce loan processing time by 20%, saving the bank $100,000 per year in operational costs (1 basis point of ROA).”
• “The new LOS will enable us to originate an additional $20 million in loans per year, generating $200,000 in net interest income (2 basis points of ROA).”

By presenting the costs and benefits in terms of basis points, decision-makers can quickly assess the project’s potential return on investment and make informed choices. The question then becomes: how long will it take to capture the efficiencies gained to break even on the 5 basis point upfront expense?

Similarly, a proposal for a new branch should be evaluated in terms of its ROA impact. The initial investment, operating expenses, and projected deposit growth should all be translated into basis points. The decision to proceed should be driven by a clear understanding of the timeline for achieving ROA breakeven.

Fostering a Culture of Financial Awareness

To effectively implement a “think in basis points” approach, community banks must invest in employee training and education. This includes:

• Financial Literacy Programs: Provide employees with basic financial literacy training, covering topics such as ROA, NIM, and cost of funds.
• Role-Specific Training: Tailor training programs to specific roles, demonstrating how daily actions impact ROA.
• Performance Metrics: Incorporate ROA-related metrics into employee performance evaluations.
• Open Communication: Foster a culture of open communication, where employees feel comfortable asking questions and sharing ideas for improving profitability.

Beyond the Basics: A More Nuanced Approach

While the core concept of “thinking in basis points” is powerful, it’s essential to consider several additional factors for a more nuanced and effective approach:

• Risk Management: It’s crucial to emphasize the importance of risk management. Chasing higher ROA without considering risk can lead to disastrous consequences. For example, offering loans with significantly lower interest rates to attract volume might boost ROA in the short term, but if it leads to higher default rates, the long-term impact could be severely negative. Always consider risk-adjusted returns.
• Long-Term vs. Short-Term: Differentiate between short-term ROA gains and long-term sustainable profitability. Some actions may boost ROA in the short term but harm the bank’s long-term prospects. For instance, cutting back on employee training to reduce expenses might improve ROA this year, but it could lead to decreased employee performance and higher turnover in the future.
• Intangible Benefits: Acknowledge that some benefits are difficult to quantify in terms of basis points, such as improved customer satisfaction or employee morale. However, these intangible benefits should still be considered in decision-making. A friendly and helpful staff can lead to increased customer loyalty and referrals, which ultimately contribute to long-term profitability, even if it’s hard to measure directly.
• Technology and Data Analytics: Banks need robust systems to monitor performance and identify areas for improvement. This is where technology and data analytics come in. Banks should invest in systems that can track and measure the ROA impact of different products, services, and customer segments.
  • Measuring Product Profitability: Data analytics can be used to determine the true profitability of each product. For example, a bank might offer a high-yield savings account to attract deposits. However, if the cost of managing those accounts (including marketing, customer service, and regulatory compliance) is high, the product might actually be decreasing overall ROA. By tracking all the costs and revenues associated with each product, banks can make informed decisions about which products to promote, modify, or discontinue.
  • Leveraging Technology: Technology can also automate many of the tasks involved in tracking and measuring ROA impact. For example, automated reporting systems can provide real-time data on key performance indicators, allowing managers to quickly identify and address any issues. CRM systems can track customer interactions and identify opportunities to cross-sell or up-sell products, thereby increasing revenue.
• Competitive Landscape: Emphasize the importance of understanding the competitive landscape and benchmarking performance against peers. Are you gaining or losing basis points relative to similar banks?

Conclusion

“Thinking in basis points” is more than just a financial exercise; it’s a cultural transformation. By empowering employees at all levels to understand and contribute to the bank’s financial performance, community banks can unlock their full potential and achieve sustainable profitability. When everyone is “rowing in the same direction,” guided by a shared understanding of value, the results can be transformative. By investing in employee education, fostering open communication, and embracing a data-driven approach, community banks can create a culture of financial awareness that drives long-term success.