Case 090Bank economics, fees and riskWarm up

A relationship manager's scorecard shows a book of Rs 250 crore, net new money of Rs 30 crore, revenue of Rs 2.2 crore and cost of Rs 70 lakh. What are his return on assets and cost coverage, and what does the bank read from them?

The situation

An invented private bank's year-end scorecard for one relationship manager: closing book Rs 250 crore, opening book Rs 205 crore, net new money Rs 30 crore (so markets added Rs 15 crore), revenue Rs 2.2 crore and fully loaded cost Rs 70 lakh, which includes his pay and a share of the desk's costs.

Revenue splits into Rs 1.3 crore of recurring advisory fees and fund trail, and Rs 90 lakh of transactional income from structured products and new issues. The desk's medians, also invented, are a return on assets of 75 basis points, cost coverage of 2.5 times and net new money growth of 8%.

Your task

Compute the return on assets, the cost coverage and the growth, and say what the bank reads from them.

Quick check

What is his return on assets on the average book?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

Return on assets is about 97 basis points on the average book and cost coverage is 3.14 times, both well above the desk. Net new money of Rs 30 crore is 14.6% growth. The bank's question is quality: Rs 90 lakh, 41% of revenue, is transactional, about 40 basis points, which can vanish in a quiet year and may reflect product pushing. The recurring 57 basis points is the part it values most.

Step 1Why is the size of the book not the score?

Because a large book earning little is worth less than a smaller one earning well. A shop's floor space says nothing until you know the sales per square foot. The bank judges a book by what it yields, revenue over assets, and by what it costs to run, revenue over cost; size only enters as the denominator. Two managers with Rs 250 crore each can differ by a factor of two in value to the bank.

The scorecard's four numbers become three ratios: a return on assets of 97 basis points on a Rs 227.5 crore average book, cost coverage of 3.14 times, and net new money growth of 14.6%.

Step 2How are the ratios computed, and why use the average book?

Revenue was earned all year on a book that grew from Rs 205 crore to Rs 250 crore, so divide by the average, Rs 227.50 crore. Rs 2.2 crore over Rs 227.50 crore is a return on assetsRevenue earned on a client book divided by the assets in it, usually quoted in basis points; the yield of the book to the bank. of about 97 basis points; on the closing book it would read 88. Cost coverage is Rs 2.2 crore over Rs 70 lakh, 3.14 times, which is the same as a cost-income ratio of 32%. Growth is net new money over the opening book, 14.6%; the Rs 15 crore markets added does not count as his.

Measure	This manager	Desk median	Reading
Return on assets	97 bps	75 bps	Well above
of which recurring	57 bps		Stable part
of which transactional	40 bps		Check what drove it
Cost coverage	3.14x	2.50x	Well above
Net new money growth	14.6%	8.0%	Well above

Against invented desk medians, the manager's 97 basis point yield, 3.14 times coverage and 14.6% growth are all well above, but 40 of the basis points are transactional.

Step 3What does the bank read from them?

A strong year that needs one question answered. Recurring revenue of 57 basis points is close to the desk's whole yield, which is good; the extra 40 basis points of transactional income is what lifts him far above it, and that part repeats only if clients keep buying products. The bank will look at which products, for which clients, before paying for it, because a high transactional yield is also what a product-pushing book looks like. Close with the limit: one year is a small sample, and a quiet market next year could cut transactional income by half without any change in his skill.

Where candidates lose it

Candidates divide by the closing book and get 88 basis points, or quote the book's size as the achievement. Revenue was earned on the average book, and size is not the score.

The second miss is reading a high return on assets as simply good. The split between recurring and transactional revenue is what the bank actually studies, because the second can signal pressure selling.

What the interviewer asks next

He brings in Rs 50 crore next year from one family at 30 basis points. What happens to his ratios, and is it good business?
How would you raise the recurring share of his revenue without cutting total revenue?
Why might a bank accept a lower return on assets from a very large client?

Company names and figures are illustrative.