Use profitability terms when talking with your executive team.

• Author: Marsico, Jeff
• Position: STRENGTHENING YOUR CORE

MARKETERS TEND TO BE MORE CREATIVE than other bank executives and sometimes use terminology that can solicit blank stares. But reporting to your CEO on how you intend to improve the return on equity (ROE) of specific underperforming branches to raise the overall bank ROE would be a different story.

ROE is one of the most common gauges of your bank's financial performance. it is a simple calculation at the whole bank level. But what about at organizational units (i.e. branches, lending, etc.) and products? Here is where profitability measurement is instrumental in making decisions to improve overall performance. Organizational and product profitability has three basic components that you should understand:

* Cost Allocation. The operating expense to run a branch goes beyond the direct expense of the branch itself: What about information technology, operations and marketing? Every financial institution requires a rational means to allocate "support center" and "overhead" costs to profit centers and products--to determine the "all in" cost.

* Funds Transfer Pricing (FTP). Most of your bank's revenues probably comes from the spread. But how do you calculate the profitability of a branch whose balance sheet is mostly made up of interest-expense generating deposits? The answer is FTP, providing a market-rate funds credit for all deposits within the branch.

* Capital Assignment How would you calculate ROE of a home-equity loan if you don't assign the "E," or equity, to this product? You can't. The best practice for assigning capital to products and organizational units is based on the risk characteristics of the product or the products within the profit center. This method is termed "risk adjusted return on capital" or RAROC.

Knowing those three components will help you communicate to the C-suite in your bank, especially the chief financial officer. So how do you discuss your plans to improve the profitability of struggling branches?

The fundamental manner to improve profitability is the same in all industries: either grow revenues or reduce expenses or some variation of the two. To improve the ROE of the branch, grow revenues, reduce expenses or reduce...