If Football is a Game of Inches, Banking is a Game of Basis Points.
Marc Winkler
Partner, Business Strategy
Not only is football a game of inches, so too is baseball, golf and almost every other sport. Horseshoes is a game of inches. In horse racing, first and second might be determined by a “nose”. Several inches, an inch or even a “nose” can mean the difference between winning and losing. So too in banking, but instead of inches, it’s basis points (“BPs”). A basis point is just one-hundredth of one percent or .01%, but add them together and they have a significant impact on bank performance.
Banking is a leveraged business with very narrow margins. Every BP in yield on earnings assets, cost of funds, non-interest income or non-interest-expense has an impact on a bank’s earnings. Ensuring that the institution is generating a good return depends on earning every BP possible, within appropriate risk parameters. The primary benchmark of bank performance is Return on Assets (“ROA”). If a bank is generating a 1.0% ROA, adding 10 BPs translates into a 10% increase in earnings, assuming a static balance sheet. There are many moving parts in generating annual earnings increases but identifying opportunities for every 1 BP improvement can contribute to significant profit and efficiency improvements.
For example, using a $500 million bank, every 1 BP improvement on assets either in interest income, interest expense, non-interest income or non-interest expense would result in an additional $50,000 in pre-tax earnings. A combination of actions resulting in 5 BPs of improvements would add $250,000 to the bottom line and increase the organization’s ROA.
There’s intense competition that affects pricing on loans and deposits, along with yields on investments. Markets and the economy are in constant flux but focusing on where opportunities exist to for each BP improvement will provide earnings improvements. Early in my career I learned that in a leveraged business the “nickels and dimes” add up. It’s still true today and BPs are those nickels and dimes.
An approach to BPs improvement is reflected in the Japanese management methodology of Kaizen. “Kaizen is a concept referring to business activities that continuously improve all functions and involves all employees from the CEO…to line workers.” Kaizen is an attitude that “refers to any improvement, one-time or continuous, large or small…” and can be applied to identifying, on an on-going basis, every opportunity to add a BP to earnings and ROA.
Emphasizing a corporate culture of looking for 1 BP improvements whether in strategic planning, loan and deposit pricing, setting fees and expense management can be a useful approach to identifying and realizing profit improvements. And, instilling a culture of identifying every 1 BP improvement throughout the organization’s management and staff can have a very positive effect on both short and long term performance leading to an increasing ROA.
Increasing ROA’s leads to improvements in Return on Equity and accelerated growth in earnings and capital, and ultimately enhances the value of the institution. Long term, the institution reinforces its ability to increase its loan limits, expand loan growth in its markets, increase contributions to support the local community, invest in technology, expand services and continue to provide competitive pay levels and benefits to employees.
And, as Vince Lombardi said:
“Football is a game of inches and inches make the champion.”
Yes, those “inches”, or in banking BPs, can add up and make the champion!