Price Relationships, Not Loans

Commercial banks are struggling to bring in income from loans.

This isn’t a new flash, but it does bear repeating. And this chart illustrates the degree of the decline.


Source: S&P;Loan contribution calculated as interest income earned on loans as a percentage of total bank revenues.

In each segment of the commercial banking industry, loans are contributing less to the bottom line than they did four years ago. Among the biggest banks, the drop has been particularly significant. 

Faced with those numbers – which confirm the anecdotal evidence and gut feelings that bankers have had for some time now – commercial banks are left with a choice.

Option 1: Reverse the Trend

Banks can try to aggressively take market share from competitors, and grow enough to offset margin compression, thus adding more total income. 

Given how hypercompetitive the commercial loan market is, that seems like an improbable solution. While reducing rates could boost volume, that’s likely to cut deeply into profitability, not to mention putting a dent in the portfolio’s risk profile.

Option 2: Reduce Costs (Again)

Banks can try to offset the drop in loan income by achieving greater reduction in the cost it takes to win those loans. That strategy will likely feel like squeezing blood from a stone for most banks, which have been searching for efficiency gains in every nook and cranny ever since the last financial crisis.   

Option 3: Lean Into the Trend 

Stop trying to fight this trend and instead shift your sales strategy to incorporate it. Treat it like a market condition that must be accounted for, and not some sort of glitch that must be fixed. 

To do that, banks need to shift from a mindset of “pricing loans” to “pricing relationships.” 

Low on Loan Income, High on Total Income

Banks that focus on pricing relationships sometimes have to let go of the idea that every individual commercial loan will look like a “win.” Instead they look at the loan as part of a larger cross-sell strategy, where other products have the greater impact on profitability. 

A couple of non-bank analogies: movie theaters often make little on the actual tickets they sell, but turn their profits on the concessions moviegoers purchase once in the theater. Car sales don’t have large margins. Dealerships make their money on the ongoing maintenance they later provide for the car buyers. 

Back to the banking world: Here are a few banks that have been willing to trail their peers when it comes to loan profitability (Risk-Adjusted Net Interest Margin), but have benefited from shifting their focus to the full relationship profitability (Total Risk Adjusted Earnings).


Two things worth noting:

  1. This is Citi’s performance vs. its peers, so the argument that “it’s easier for big banks to concede margin on loans,” doesn’t really hold here.
  2. It’s also possible for smaller banks to achieve success with this approach, as shown by UMB, a $20B regional bank.


3 Keys to Pricing Relationships

How can your bank produce similar charts to Citi and UMB? It requires several steps, some tangible and others intangible. 

Shift Mindset/Shift Incentives

First, you have to shift the mindset of your relationship managers. This requires a measured approach in how you communicate the bank’s strategy. 

You want RMs to understand that it’s okay to concede in a rate negotiation on the loan IF that concession is part of a larger discussion around the relationship and additional non-credit income opportunities. 

To do that, you may need to shift how you’re incentivizing your RMs. Compensation plans based purely on loan growth won’t cut it. Instead, RMs need to be rewarded for total relationship income. That ensures they’ll have conversations with clients about, say, bringing over deposits from other banks, or that – when the RM offers a lower rate on the loan, they’ll make sure it’s tied in with the client adding another product, like treasury management services. 

Put simply: You want your RMs with a cross-sell mindset. To do that you need incentives that reward cross-sell behaviors. 

Offer Full Relationship Visibility

It’s not enough to tell RMs to think of the full relationship when structuring a deal – you have to give them the ability to see it. When they’re working with a client to structure a deal, they need to know what accounts the client currently has with the bank, the current profitability of the relationship, and how each potential new product may affect that critical number.  
RMs weighing whether to offer favorable terms on a commercial loan can make that decision with confidence if they know that winning that loan will also mean additional non-credit income that lifts the overall relationship profitability past the bank’s revenue targets.

Track Cross-Sell Promises

Every sales manager has a story about an RM who’s notorious for using the promise of additional deposits to get a loan pricing exception – and then rarely ever gets the client to bring those deposits over. 

At that point the loan doesn’t become a loss leader – it’s just a loss. 

To avoid that, your bank needs to put in a system for tracking that the promise of additional non-credit accounts eventually comes to fruition. It needs to operate on two levels. First, the RMs need it, so they can offer gentle – but firm – reminders to clients to bring over those accounts. Second, sales managers need it so they can make sure the RMs are diligently following up with the clients. 

Loans as a Means, not an End

At the end of the day, your bank is judged by its overall bottom line, not by whether a certain sector did well at the expense of everything else. While it’s scary to think of loans producing less income, it’s a reality that banks need to adjust to – the sooner, the better. That doesn’t mean giving up on loan profitability; rather, banks need to view it through the wider lens of the overall relationship.  


About the Author

Jim Young

Jim Young, Director of Content at PrecisionLender, is an award-winning writer with experience in a range of positions in media and marketing, from reporter to website editor to content marketer. Throughout his career Jim has focused on the story – how to find it, how to understand it, and how best to share it with others. At PrecisionLender, he manages the many ways in which the company shares its philosophy on banking and the power of relationships. Jim graduated Phi Beta Kappa from Duke University and holds a masters degree in journalism from Columbia University.

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