Last week we wrote a blog introducing you to the premise behind our latest white paper: “Are You the Bank of Last Resort?” We talked about what it looks like when you’re in that uncomfortable position as the bank that customers only turn to when they want to see if you’re willing to undercut everyone else in the market.
But what about the flip side? What does it look like when you’re at a Bank of First Resort? The paper also goes into detail about why the pricing conversations at those banks are different, and better.
We looked at data from high-performing banks to show how top relationship managers (RMs) craft deals that meet both the customer’s needs and the bank’s goals. This was beautifully illustrated by the use of caps & floors.
Sharing the Risk, Lowering the Costs
Strong RMs are skilled at understanding the biggest fears of their customers and taking the steps to alleviate them, adding important value in the process.
Both banks and customers are afraid of sudden change in interest rates. For banks, sharp movement in either direction can adversely affect net interest income. For customers, the cause and effect is simple: higher rates mean higher payments. That’s particularly a problem early in the loan, when the balance is highest.
Not surprisingly then, customers prefer the certainty of longer term, fixed-rate structures – i.e. the opposite of what banks want. How then, to reconcile these contrasting desires? For many banks, the answer is to capitulate to customer and hope to eek out a slim profit.
Banks of First Resort instead opt to get creative.
When we looked at our data we found that top RMs offered variable-rate loans more often than their lower-performing peers (50% ot 39%). More importantly top RMs were five times more likely to use caps and floors on those deals.
Those deals generated strong returns, with an average ROE of 30%.
Here’s why this works for all parties involved.
With a cap, customers get insurance that they won’t be dangerously exposed if rates do spike. Meanwhile the floor gives banks a guaranteed minimum rate of earnings. Both sides are sharing the rate risk.
Also, banks are able to offer the deal at a low price to customers and still get a great return because they’re shortening the duration significantly. The cap/floor deals of top RMs were on average 1/5th as long as the deals other RMs booked. A cap/foor for a one-year deal is significantly cheaper than one on a five-year deal. So much so that top RMs are able to pass along savings to their customers while also ensuring a great return for the bank.
It’s a classic win-win deal for the bank.
For more on caps and floors and other ways that Bank of First Resort separate themselves from the pack, download the white paper.
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