Transaction Banking: Why Sticky Relationships Matter
I read with interest gtnews’sfocus on transaction banking, as well as the editor’s comments.
However, I believe that future success using this strategy will depend more on developing new customer and ‘sticky’ relationships than new or better transactions.
In other words, banks have ‘suddenly’ discovered that lending is a low-margin and risky business. As a result, they are seeking new ways to sell services that are more profitable on a risk-adjusted basis, to give them the growth in earnings their investors require.
This approach is not new.
Having started his career on the banking side (JP Morgan, Bankers Trust company), the writer came to banking when ‘success’ was all about building ‘relationships’ – where a bank tried to be a full service vendor to its customer and provided lending, cash management, fiduciary and foreign exchange (FX) and more.
The payoff from a relationship came when a customer liked their bank so much they rewarded it by keeping millions on deposit. This policy was used, for example, by EXXON so the bank would answer its calls promptly. The value of these excess deposits made the relationship very profitable, but was more a reward for service than product.
Customers often stayed with their banks for years because of service and responsiveness by their banker. The bottom line was that banks had a steady source of income and customers felt ‘happy’ and comfortable with their relationship manager.
As deregulation came into its own years ago and US depression-era regulations were repealed, banks focused on transactions, such as leveraged buyouts (LBOs), loan sales and others. Furthermore the larger and more creditworthy customers started to bypass the banks to go to the credit market for some or all of their needs. Relationships started to decline, evincing the following responses:
Over time banking income, especially fee income, from all types of transactions grew to spectacular heights – but so did risk as banks became highly levered, exposed to the market and each other via loan purchases.
Eventually, financial gravity took over.
Benefits and Pitfalls
The recent Great Recession exacerbated the bank’s ability to create and maintain relationships; customers looked to different banks after hearing ‘no’ too many times, as so many were licking their (often self-inflicted) wounds.
Also, customers wanted banks they could depend on. The more creditworthy companies with sufficient liquidity from operating cash flow either bypassed banks or borrowed less. To overcome lower loan growth, banks would lower their rates to sell more, taking on the same, if not more, risk. The latest Basel III capital adequacy rules only reinforced the idea that lending had become more risky.
As a result, transaction banking remained one of the few businesses that banks could offer at reasonable, risk adjusted returns. After all, payment execution provides a steady stream of income. A transaction banking strategy is inherently more profitable for banks; for one thing fees come upfront while interest income is over the life of a loan; however, this strategy has its own flaws:
On the positive side, any bank that can offer high-quality standard or bespoke services and properly tracks each customers’ ‘relationship income’ (transaction services + lending + FX + trade + fiduciary + card) can boost ROA and ROE, since transaction services require little ‘A’ or ‘E’. Also, the use of contractual language and multi-year contracts can be used to ensure a steady, if not spectacular, stream of income for years.
Truth be told, bankers are better at this transaction type of strategy than corporates are. Indeed, how many corporates today can tell you what they spend globally at their banks and for what, or if they received the service quality they paid for.
Given this new strategy, the French express it best: plus ça change, plus c’est la même chose!