Inside Your Banker’s Head

Companies are starting to figure out how their banks make money. Banks actually like that.

Almost as many — 10 percent — claim they estimate the margin that banks earn on transactions with the company. “We do have clients asking us about our model and how it works,” says Wells Fargo’s Hardy, who has made multiple presentations at treasury conferences over the past two years to explain the basic RAROC model. “And we have some clients who are trying to put together their own model.”

“We have seen a handful of companies that have taken a highly rigorous approach to this kind of quantitative analysis,” says Susan Skerritt, a partner at Treasury Strategies, a consulting firm specializing in treasury and financial management. By that she means actually trying to reverse-engineer the RAROC model used by each bank in the group. But the models vary, and several assumptions and variables are available only from one source: the bank itself.

“The companies that are doing this in the most rigorous fashion are actually requesting that their banks explain to them how that individual bank’s model is calculated,” says Skerritt. According to CFO‘s survey, 8 percent of respondents said they ask their bankers for that information. And while companies don’t always succeed in getting it, in many cases they do. “The banks understand it is in their interest for clients to understand their profitability,” she says.

Indeed, while just a few clients have asked for a look at Citigroup’s model, says Calfo, “we get as detailed as folks want to get. The greater the transparency, the better our relationship.” Former Bank of America CFO Marc Oken told CFO earlier this year that the bank holds “real detailed” conversations with companies that aren’t meeting its hurdle rates. “We will either give a customer our model or tell them why their model is wrong,” he said.

Of course, with less than 10 percent of companies actually asking for the models, banks are not under much pressure to be completely forthcoming. Wells Fargo’s Hardy, a strong proponent of improved corporate understanding of RAROC models, notes candidly that banks are unlikely to give away the store. For example, he says, banks are highly unlikely to tell corporate customers how their models assign costs to noncredit products.

For most companies that estimate the profitability of their banking business, however, it’s enough to have a single, simpler return model that estimates a common margin for services from members of the bank group (see “A Simple Return,” at the end of this article). “The highly rigorous approach where the treasurer is doing it on an individual bank basis is exhaustive but may be more than your organization needs,” says Skerritt. “But it’s absolutely a best practice to have at least one common standard benchmark.”

Doing the Math

Ken Schutte, treasurer at brokerage firm Edward Jones, uses just such a benchmark to manage his company’s 11 banks. A commercial banker for 26 years before joining Edward Jones in 2000, Schutte explains, “I was used to the concept of banks trying to evaluate the profitability of client relationships. So I just reversed it.”

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