January 2021 | Point of View

Pricing and revenue optimization for commercial banks

Banks must review treasury management fee income models given the economic environment of compressed loan margins, low cost of funds, and excess liquidity

By Jordan Sternlieb, Tom Collins, and Ron Fink

Even before the pandemic and recession struck in 2020, loan demand across the industry was beginning to lag and net interest margins were shrinking. Looking toward 2021, a top priority for banks will be to more deeply engage with their current clients. Due to the continued compression of bank margins, a reality is that banks must deepen relationships with their current clients and increase share of wallet within their existing portfolio.

We see a sizable opportunity to expand existing relationships through fee-based products and services like treasury management—a stable, low-risk source of revenue that can help commercial banks weather the current economic environment, while positioning them to improve operating margins now and as conditions improve.

Why commercial banks miss the mark on pricing optimization

In our experience working with commercial banks, we see treasury-based fee income sources often underperform maximizing value on income statements due to a host of factors: limited data visibility to identify cross-sell opportunities, lack of effective sales tools and technologies to create more seamless handoffs between lending and treasury functions, and a tendency to arbitrarily waive or deeply discount fees for perceived high-value clients.

In addition, because of the focus most RMs apply to the borrowing needs of their clients, treasury management products and their related pricing and profitability are often an afterthought in the commercial banking process. Because of this constellation of behaviors, most commercial banks have significant dormant value within their existing client relationships that can be realized through a concerted fee income optimization effort.

The areas of opportunity that can be addressed to create value typically fall into one of six categories. Although the lost fee income across these categories will vary from bank to bank, it is common for commercial banks to collect a fraction of their gross standard service fee income. As a result, the realizable value of optimizing pricing, fee income assessment, and collection practices and earnings credit rates can be is of millions of dollars annually for mid-tier banks.

These categories include:

Earnings credit rate

As the interest rate environment has continued to trend downwards, most middle market banks have not maintained a rigorous focus on managing the ECR policies and pricing. While an important value-add to the client, many banks are not maintaining a balanced approach to managing ECR thereby impacting collected fees.

Fee leakage

Banks can experience a loss of collected fee income due to service fee volume not being collected either through vendor interfaces or operational tracking of work performed.

Unpriced services

Many commercial banks do not revisit their service code structure and as a result, they provide services to clients for which they do not capture billing volumes and therefore do not charge for these services.

Expired Pricing

Introductory pricing arrangements for commercial clients are often inadvertently left to continue permanently due to the lack of appropriate process and controls.

Waivers/reversals

Services which are billed to clients but ultimately waived or reversed due to client request are significant and are typically driven by a lack of rigor and reporting across the process.

Exception pricing

Without suitable controls and analytics, like clients with similar product usage and transaction patterns can often be priced inconsistently, leading to a significant loss of collected revenue.

A road map for optimizing treasury services

We recommend banks begin the optimization process by looking at their existing client portfolio. We typically advise clients to view opportunity and interventions plotted out along a spectrum ranging from those with lighter to more acute impacts to clients. We then leverage a set of strategies to enable commercial banking organizations to unlock the value from their commercial client relationships. These strategies are broken out by client-focused and internally focused tactics:

1. Internal tactics to optimize Treasury Management (TM) fee income

Leveraging Data: Creation of a pricing data base that leverages a variety of data elements and sources such as price time volume (P*V) fees by client, deposit balances by type, loan balances by type, client profitability, product usage, won/loss data, competitor benchmarking, unit costing, and client analysis enable the bank to customize pricing down to the client level which provides greater pricing confidence, lower exception pricing while positioning the bank to adopt predictive analytics to continue to refine pricing and client profitability.

Segmentation of Clients: Segmenting clients based on retention profile, usage patterns, profitability, and propensity to use other bank products allows for the bank to deliver pricing strategies that minimize attrition and run-off while optimizing the value of the existing relationships.

Enhanced Share of Wallet Analytics: Using internal and external data to align client profile and product usage patterns with optimal/target usage enables banks to identify opportunities to improve relationship penetration, drive down attrition and increase collected fee income.

2. Client-focused tactics

Product bundling: Simplifying the pricing process by bundling services, especially for small business and business banking clients simplifies the sales process and makes it easier to align on true client needs and manage competitive pricing discussions. For clients themselves, they gain predictability of cash flow and know what to expect from their bank.

Improved pricing controls and processes: Establishing a rigorous pricing process that provides transparency across the entire footprint. This enhanced transparency gives bankers better information and insight and more standardized pricing exceptions and waivers criteria, resulting in higher collected revenue levels across the client portfolio.

3. Selling more effectively into your portfolio

Selling based on value: Top tier commercial banking teams have adopted an approach to price and sell services based on the value they provide to the client as opposed to the cost of manufacturing the service. This gets RMs out of the commoditized approach to pricing and allows them to command higher prices, especially in the middle market and business banking segments.

Improved RM sales effectiveness: Building an internal sales effectiveness competency within the RM base and creating a needs-based dialogue with clients that leverages actionable data to drive value leads to a “trusted advisor” relationship with key clients which serves to insulate the bank from pricing pressure.

Leveraging the commercial lending relationships: Setting expectations and goals for cross selling TM into the loan book. Few banks measure and manage this important key performance indicator that will drive relationship profitability.

A variety of compelling outcomes exist for Banks who have undertaken a fee income optimization effort.

Measurable and sustainable net fee income increases of up to 50% which can be attributable to one or all of the following:

Improved earnings credit rates: Can provide savings of 10% to 50% improvement on Net Fee Income
Improved pricing and controls: Reduce discounting/waivers and can contribute up to a 25% improvement in collected fees
Lower fee leakage: Depending the banks controls for collecting all volume for P*V services provided, we have seen increased billing of 3% to 25%
Enhanced client retention: Extending TM into a loan only relationship can extend the average lifetime value of a client portfolio by 75%
Cross sell penetration improvements: One mid-market bank identified up to $100 million of recurring income