Axiom Blog Utilizing FTP as a foundation for Proactive Margin Management

I recently presented a webinar on proactive margin management for banks and credit unions. Based on the interest and feedback, it seems like an opportune time to provide a summary on this important topic. Net Interest Margins (NIM) have been shrinking in financial institutions for more than 20 years. Yes, there have been short-lived, intermittent increases, but Figure 1 clearly demonstrates this prolonged, troublesome trend.Figure 1. Trends in Net Interest MarginsSource: FFIEC (US): Net Interest Margin for all U.S. Banks [USNIM]. Retrieved from FRED, Federal Reserve Bank of St. Louis, March 30, 2017.Margins of financial institutions have been suppressed for a number of reasons including a historically low interest rate environment, flattening of the yield curve, growth of deposit accounts, shrinking loan portfolios, and a shift in balance sheet structures. While margins appear to be stabilizing, analysts do not expect significant improvements any time soon.The question is: Does your institution view itself as a victim of these market circumstances, or are you utilizing every practical approach to fight for every possible basis point of margin?" One of these approaches should be a proactive margin management process that leverages a fresh take on funds transfer pricing (FTP) as its cornerstone. In my 20+ year career in the banking industry, FTP has posed some of the biggest challenges for financial institutions and is widely underutilized by the industry as a whole. Potential barriers include a lack of knowledge of what FTP is, how it works, or what value it can provide; significant political and cultural issues that prevent successful adoption and use of FTP; and the oversimplification of the FTP methods currently employed. In an environment of tight margins, utilizing FTP as a tool for proactive margin management-as opposed to simply another measurement system-provides institutions with an opportunity to improve their bottom-line results. Let's dive a little deeper.Proactive Margin ManagementTo better understand, plan, and improve margins, your institution can implement a proactive margin management process that utilizes FTP for historical analysis and measurement. It also should include forecasted FTP as part of the strategic planning, "what-if" process, and incorporate FTP in the budgeting and forecasting processes to ensure alignment with organizational goals and strategies. A standard enterprise performance management cycle (Figure 2) can be applied on a more granular level to focus specifically on margin management.Figure 2. Enterprise Performance Management CycleHistorical Analysis (Opportunity Identification)Many people have questioned the worth of historical performance analysis, wondering what value it adds for future performance. Think back to your history classes. We didn't study history because it was going to predict the future (history typically does not repeat itself); we studied history so we could learn from the past and use that knowledge as a foundation for our journey into the future. Historical analysis can, and should, be used as a tool to help identify areas of weakness and opportunities for improvement. By understanding the NIM and profit contribution of each segment (e.g. branch, product, customer/member, officer, and channel), you can identify areas of under-performance and potential opportunities for improvement.Strategic Planning (Opportunity Evaluation) Once the potential opportunities for performance improvement have been identified through historical analysis, you can utilize "what-if" scenario analysis to evaluate various strategies. For example, strategic alternatives may include growth strategies for particular product segments, modifications in pricing strategies to improve spreads, channel strategies to drive existing and/or new customers to more profitable channels, or market analysis to determine if the institution should open or potentially close branches in certain markets. By forecasting FTP as part of the scenario modeling and evaluation processes, your institution can project specific financial metrics (including NIM) for each segment and the institution as a whole, in order to agree upon a strategy that optimizes financial performance.Budgeting and Forecasting (Opportunity Execution)Employing a detailed budgeting and forecasting process lets you develop, implement, and execute a tactical plan to achieve agreed-upon strategies. Typical budgeting and forecasting processes focus on volumes, rates, and non-interest income/expense items. By also including forecasted FTP in the budget process (and subsequent forecasts), you arrive at NIM for each segment. This enables the institution to better plan, track, and evaluate performance objectives that are in alignment with the overall goals of the institution.In ConclusionI was recently told by a friend (who is also the Treasurer at a mid-sized bank): "In these challenging times, every basis point of margin should be treated as gold." With this in mind, I encourage you to employ a proactive margin management process to fight for every basis point of margin. Now is the time to leverage FTP to its full capabilities, utilizing it as a key decision-making tool within your organization to help drive performance to the next level. Don't let your margin manage you-instead, proactively manage your margin.