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BirdsEye View

teaching our employees how we make money: second "take"


Quote of the week, from a very wise bank CEO: "This round of bank failures is going to change the competitive landscape for at least a couple of decades.  We're happy to participate in the gardening."


Have a fabulous fall,


Anat



Article synopsis: Teaching our employees how banks make money is the best way to motivate them to the the right thing for shareholders, customers and employees alike.



TEACHING OUR EMPLOYEES HOW WE MAKE MONEY: SECOND "TAKE"


I received so many great comments on my article regarding the need of employee education! Many of you asked for more details, hence this article. I mobilized the assistance of my good friend Bob Baroni of Commerce Bank. Bob and I worked together in the past; he has a great understanding of the relationship between employee actions and bank financial results. He also has a sense of humor that cracks me up time and time again. The article below is based on many of his thoughts and materials, as well as great insights from my mentor and past Chairman, Stan Bradshaw.

First, let's be clear why profitability is important. Banks need capital in order to operate and grow. Capital is generated through stock issuance, some debt issuance, and retained earnings. Earnings are the gateway to capital accumulation for banks. Further, profitability is very important to bank stock price, which, in turn, plays a critical role in acquisitions where stock is being used to buy another bank. Deals such as PNC-National City or Wells Fargo and Wachovia would not have happened if the acquired bank's stock has performed well and if their earnings were strong.

Then, let's teach our people about where revenue comes from. Banks' net income equals the revenue a bank collects minus all the expenses. Income has four components:

  • Interest we receive (interest income) from borrowers and from bank investments

  • Fees we receive (non-interest income) from retail, commercial, wealth management, treasury management, insurance etc. customers

  • Interest we pay (interest expense) is deducted from revenue. This is the rate we pay on our deposits and on bank borrowings from other banks and the government. The blended rate of all interest expense is the bank's cost of funds.

  • Margin (net interest income) is the difference between the money we receive (interest income) and the money we pay (interest expense). The greater the difference between the interest we receive on loans and investments and the rate we pay on our deposits, the greater the margin. In most community banks, the margin accounts for 80% or more of their income.

Showing an example of margin calculation is very helpful. You might even take it further and show the difference sources of interest income at your bank: investments; C&I loans; real estate loans; consumer loans; mortgages etc., so your employees will have a solid understanding of where your main source of income comes from. You can further show which lines of business generate more interest income and explain why (the risk/return equation). For example, you get less interest on government T bills and more on consumer loans.

A similar example can be made for deposits: their various interest costs, which ones are higher (more costly) and which ones are lower (free checking wins, of course). Our employees are smart enough; they'll understand the information and will then be able to relate it to their daily activities and their job.

Fees should come next: NSFs, other consumer fees, commercial fees. Etc. This might be a great place to show your employees the cost of waiving 1% of consumer fees, 1% of commercial fees, 1% of wealth management fees etc. I'm confident most don't know how large that number is, and how important to the bank's profitability. Most employees believe fee decisions are very small and inconsequential ("How can it matter if I waive a $30 charge?" logic).

Employees need to also understand where the bank's expenses come from and what are the largest categories. Expense categories will give them insight on where the bank spends its money. Many will be surprised to learn that salaries and benefits are the largest expense category...

Loan loss provision is always a critical expense category, and today more than ever. Showing your staff how much money gets put aside against possible future losses and how it impacts your revenues is very telling.

Net operating income, taxes and net income come next, and complete the "How we make money" question. You might want to use this opportunity to further link net income to capital and the shareholder base. Employees believe that senior executives have no bosses, where, in fact, the marketplace (and the board as its representative) are their supervisors. Employees understand executive decisions much better when they "get" the relationship between shareholders and executive management.