Cost Allocation for Financial Services | CostPerform https://www.costperform.com World Class Activity Based Costing software Tue, 12 Aug 2025 10:37:57 +0000 en-US hourly 1 https://wordpress.org/?v=6.9 https://www.costperform.com/wp-content/uploads/2019/11/costperform-favicon-150x150.png Cost Allocation for Financial Services | CostPerform https://www.costperform.com 32 32 8 Steps to Build a Bank Profitability Model That Works https://www.costperform.com/design-a-profitability-model-for-banks-in-8-steps/ Tue, 12 Aug 2025 10:30:04 +0000 https://www.costperform.com/?p=13037 With 8 clear steps you too can design your profitability model! This not just applies to banks but also to other organizations.

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Key Takeaways

  • Define your goals before starting the model design.

  • Design your model on paper before moving to digital tools.

  • Identify the necessary data and how to extract it.

  • Use a dedicated tool to build your profitability model.

  • Validate your outcomes and revise the model as necessary.

  • Automate as much of the process as possible to save time and effort.

  • Document every step of the process for future reference and continuity.

In the complex and dynamic world of banking, having a robust profitability model is essential. It provides a clear understanding of revenue streams, cost drivers, and the overall financial health of the organization. 

To make better decisions, banks need a clear, trusted view of where value is create and where it’s lost. A profitability model provides exactly that. In this guide, we walk you through eight practical steps to design a profitable model for banks that is accurate, transparent, and effective.

Step 1: Define Your Goals

Before you begin, it’s crucial to determine what you want to achieve with your profitability model. Are you seeking a monthly view of profitability per client, product type, branch, or channel? Do you want it on a monthly, quarterly, or yearly basis? Defining your goals will guide the design and implementation of your model.

Step 2: Design the Model

Once you have a clear goal in mind, you can start designing the model. This step involves creating a cause-and-effect relationship to understand how different factors affect profitability. It’s best to start this process on paper before moving to digital tools.

Step 3: Design Your Data Model

After designing your model, the next step is to figure out the data you need to support it. This involves identifying the data sources, how often they’re updated, and how to extract the data. You’ll need to map your design model to your data to ensure that you have all the necessary information.

Step 4: Start Modeling

With your data and design model ready, you can start building your profitability model using a tool. Avoid using Excel as it can lead to confusion and lack of transparency. Instead, use a dedicated tool like CostPerform or any other that suits your needs.

Step 5: Validate Your Outcomes

After building the model, you’ll have some outcomes. It’s crucial to validate these outcomes to ensure that your design was correct. This step involves an iterative process of checking the results, revising the design, and re-running the model.

Step 6: Build Your Reports

Once your outcomes are validated, you can start building reports. These reports should present the data in a clear and understandable format for those who will be using them.

Step 7: Automate the Process

To save time and effort, automate as much of the process as possible. This includes data inflow, creation of new months, and report building. Your profitability model tool should be able to assist with this automation.

Step 8: Document Everything

Lastly, document every step of the process. This ensures that if you’re unable to continue with the project, someone else can pick up where you left off. Documentation also serves as a valuable reference for future model building.

A well-built profitability model turns data into decisions, and decisions into stronger results. By following these eight steps, you’ll create a model your teams can trust and act on – driving better margins, smarter resource use, and lasting performance. 

Contact us to learn more or request a demo below.

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]]> Understanding the Impact of Operational Costs vs. Other Banking Costs on Profitability https://www.costperform.com/understanding-the-impact-of-operational-costs-vs-other-banking-costs-on-profitability/ Wed, 12 Jun 2024 09:34:23 +0000 https://www.costperform.com/?p=16281 Learn the distinction between operational costs and other banking costs in the context of banking

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Key Takeaways

  • Operational costs are a significant factor in the banking sector’s profitability equation, alongside default risk and cost of money.
  • Digital transformation in banking offers potential for operational cost reduction.
  • Operational costs, being more controllable, play a critical role in strategic financial management.
  • Adapting to market factors outside a bank’s control, like cost of capital and loan default risks, is essential for maintaining profitability.
  • Proactive risk management and predictive modeling are vital for navigating uncertainties in loan portfolios.
The conversation around banking costs often centers on several key elements that impact a bank’s profitability. While revenues are important, this post will delve into the cost side of the equation, focusing predominantly on the operational costs associated with banking, and comparing them to other significant costs such as default risk and cost of money. The goal here is to unravel the complexities of banking profitability and highlight the areas within a bank’s control that can significantly impact its bottom line.

The Threefold View on Banking Costs

  1. Default Risk: At the forefront of banking risks is the default risk, which refers to the possibility of a loan not being repaid. This risk directly affects a bank’s profitability, as loans represent a significant portion of a bank’s revenue stream.
  2. Cost of Money: This is essentially the cost banks incur to acquire the funds they lend out. It is influenced by several factors, including interest rates set by central banks and the market’s current yield curves.
  3. Operational Costs: Operational costs in banking cover a wide spectrum, including the expenses of running brick-and-mortar branches, digital platforms, staffing, IT infrastructure, compliance, and more. This area has seen a considerable shift with the digital transformation in banking, aiming at reducing these costs while improving efficiency and customer service.

Why Operational Costs Matter

Contrary to the belief held by some banking professionals, operational costs significantly affect a bank’s profitability. These costs are more controllable compared to the external factors affecting default risks and the cost of money. Banks have engineers and financial analysts dedicated to optimizing operations to be as efficient as possible. They manage staffing levels, branch operations, and technological investments to ensure the bank operates smoothly and cost-effectively.

Digital Transformation: A Game Changer

The shift from traditional branch banking to digital platforms represents a substantial opportunity for banks to slash their operational costs. Digital banking reduces the need for extensive physical infrastructure and the associated expenses. Moreover, it offers banks the agility to adapt to changing consumer behaviors and expectations, further enhancing their profitability.

Navigating Default Risks and Cost of Money

While operational costs are within a bank’s influence, default risks and the cost of money often depend on external market factors and the broader economic environment. The post-pandemic landscape has brought new challenges in these areas, especially with heightened uncertainties in loan defaults and fluctuating interest rates. Banks must employ sophisticated risk management strategies and utilize predictive modeling to proactively manage these risks and safeguard their profitability.

Embracing the Full Spectrum of Banking Costs

Understanding and managing operational costs is undoubtedly crucial for bank profitability. However, a comprehensive approach that also addresses default risks and the cost of money is essential. Through strategic management of operational efficiencies, proactive risk management, and adaptability to market changes, banks can navigate the complexities of the financial landscape and maintain robust profitability margins.

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]]> The Strategic Evolution of Banking: Balancing Branch-Based and Digital Models in the US and EU https://www.costperform.com/the-strategic-evolution-of-banking-balancing-branch-based-and-digital-models-in-the-us-and-eu/ Tue, 11 Jun 2024 09:34:23 +0000 https://www.costperform.com/?p=16275 In Europe, as well as the United States, the industry has evolved significantly

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Key Takeaways

  • Profitability in banking hinges on understanding and optimizing the most lucrative products, customer profiles, and banking channels.
  • Branch banking continues to hold value despite the digital shift, requiring a balanced approach in both the US and EU markets.
  • Modern banking strategies must encompass the strengths of both digital and physical branches to enhance customer experience and operational efficiency.
  • Analyzing and prioritizing high-value relationships and customer segments lead to improved cross-selling and growth opportunities.
  • The evolution of banking channels, including hybrid models, offers insights into future banking operations and customer engagement strategies.
The banking sector has long been at the forefront of economic development and innovation, adapting continuously to the changing demands of the marketplace and consumer behavior. The comparison between branch banking and digital banking, particularly when examining the variances between the United States (US) and Europe (EU), provides a comprehensive understanding of the current banking landscape. This blog post delves into these differences, focusing on the profitability, customer experience, and future direction of the banking industry.

Understanding Profitability in Banking

At its core, a bank’s profitability is directly tied to its ability to understand and leverage its most profitable products and customer segments. In the broader perspective, considering products ranging from simple checking accounts to complex investment services, banks aim to identify and enhance offerings that not only attract customers but also secure their loyalty and increase their lifetime value.
Profitable Customer Profiling: Identifying profitable customer segments allows banks to tailor their services, optimizing not only the customer experience but also the bank’s return on investment. This involves an in-depth analysis of customer behaviors, preferences, and financial needs.
Cross-Selling Strategies: Building on the knowledge of profitable customer segments, banks can effectively cross-sell, promoting additional products and services to existing customers. This strategy not only boosts profitability but also strengthens customer relationships.

Branch Banking vs. Digital Banking

The ongoing debate between the efficacy and profitability of branch banking versus digital banking is nuanced. The US, with its extensive branch banking network, and the EU, with a more rapid adoption of digital banking, provide contrasting yet insightful perspectives.
Branch Banking Strengths: Physical branches, traditionally seen as cost centers due to their operational expenses, continue to offer significant value in terms of customer service and relationship building, particularly for complex transactions or advice-oriented services.
Digital Banking Advantages: Digital channels are often heralded for their cost efficiency and convenience. The ability to offer 24/7 services with lower overheads is a clear advantage in today’s fast-paced world.

The Hybrid Model: Integrating Digital with Physical

A hybrid banking model, combining the strengths of both digital and physical branches, emerges as a strategic solution. This model supports the convenience and efficiency of digital channels while retaining the personal touch and complex problem-solving capabilities of traditional branches.
Customer Experience at the Forefront: Enhancing customer experience is central to the hybrid model. Banks are exploring innovative solutions such as remote consultations via digital platforms, touch-screen services in branches, and AI-driven personalized banking experiences.

Future Directions: Innovation and Customer-Centric Strategies

As banks navigate the future, the focus will increasingly rest on innovative strategies that prioritize customer needs and preferences. Understanding the profitability dimensions of different channels and customer segments is crucial for banks to stay competitive.
Leveraging Data for Personalization: Advanced analytics and AI offer banks unprecedented insights into customer behavior, enabling personalized services and predictive banking solutions.
Operational Efficiency and Sustainability: Streamlining operations, reducing costs, and increasing sustainability are ongoing priorities. Digital transformation plays a critical role in achieving these objectives, enhancing both profitability and customer satisfaction.

Conclusion

In the shifting landscape of banking, balancing the traditional strengths of branch banking with the efficiency and convenience of digital channels is key. Both the US and EU markets offer valuable lessons in adapting to consumer demands, technological advances, and the quest for profitability. As the industry evolves, banks that prioritize innovation, customer experience, and a balanced approach to channel management will continue to lead.

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]]> Navigating Financial Challenges with Advanced Banking Profitability Models https://www.costperform.com/navigating-financial-challenges-with-advanced-banking-profitability-models/ Mon, 10 Jun 2024 09:34:22 +0000 https://www.costperform.com/?p=16293 Advanced models like Cost Allocation are critical in 21st century banking
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Key Takeaways

  • Understanding cost structures and cause-and-effect specifics can improve banking efficiency.
  • Profitability models help identify where to cut costs without affecting product quality.
  • Recognizing growth opportunities is crucial for maximizing return on investment.
  • Advanced models, including those using AI, can aid in scenario planning and faster decision-making.
  • Balancing cost, growth opportunities, and investment strategies is essential for a bank’s bottom line.
In today’s competitive banking environment, understanding the intricacies of cost modeling and the cause-and-effect dynamics that impact an institution’s bottom line has never been more critical. This blog post delves into the complexities of financial modeling, highlighting the significant impact such practices have on the banking sector’s overall health and efficiency.

Understanding Cost Structures and Their Impacts

At the core of financial efficiency within a bank lies a clear comprehension of its cost structures. Fixed costs, for instance, remain unchanged regardless of the business volume, presenting a relatively stable element of financial planning. However, variable costs, such as those associated with human resources, fluctuate with the bank’s growth and sales volumes. An increase in sales often necessitates an expansion of the workforce, implicating additional costs from salaries, contracts, and HR processes. Recognizing and planning for these variable costs is critical in maintaining financial stability and supporting sustainable growth.

The Role of Profitability Models

Profitability models serve as vital tools for banks, offering insights into potential efficiencies and growth opportunities. These models are designed to dissect the cost structure meticulously, identifying areas ripe for cost reduction or process redesign. In essence, they enable banks to eliminate unnecessary expenditures and enhance operational efficiencies, thereby directly improving the bottom line.
Furthermore, profitability models are instrumental in uncovering growth opportunities. In an era where financial resources are increasingly scarce, the ability to maximize dollar spend is paramount. Assessing past investments helps banks understand where to allocate funds for maximum return, be it through expanding customer bases or enhancing existing customer relationships.

Leveraging Advanced Modeling Techniques

The advent of artificial intelligence (AI) has introduced new possibilities in financial modeling. AI’s capability to process vast volumes of data and identify trends significantly enhances scenario planning and decision-making processes. For banks, this means being able to anticipate market shifts, customer behavior changes, or risk factors more accurately and swiftly, allowing for proactive rather than reactive strategies.
However, it’s essential to strike a balance between the complexity of models and their maintenance costs. While sophisticated models that handle numerous scenarios can provide extensive insights, they also require substantial resources to remain current and effective. Finding the optimal balance between detail and practicality ensures the models provide value without becoming a financial burden.

Conclusion

In conclusion, as banks navigate through the complexities of the financial landscape, the significance of robust cost modeling and understanding cause-and-effect relationships cannot be understated. These practices not only underpin operational efficiency and strategic growth but also ensure the bank’s resilience in the face of changing market dynamics. By embracing advanced modeling technologies and maintaining a keen focus on profitability, banks can secure their bottom lines and foster long-term success.

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]]> Unlocking Profitability: A Deep Dive into Cost and Performance Management in Finance https://www.costperform.com/unlocking-profitability-a-deep-dive-into-cost-and-performance-management-in-finance/ Fri, 07 Jun 2024 09:34:22 +0000 https://www.costperform.com/?p=16287 Cost management might be the missing secret in your profitability challenges. See how it can drive management decisions.

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Key Takeaways

  • Over 15 years of cost and profitability management experience provides unparalleled insights into financial services.
  • Specialization in the financial sector since 2008 has allowed for a focused approach to cost management and profitability.
  • Holistic strategies in cost management can significantly enhance profitability by offering more than just cost-cutting measures.
  • The experience of working with top US banks demonstrates proven success in implementing effective cost and profitability management solutions.
  • Embracing a broader view of profitability management opens up opportunities for financial institutions to optimize their performance in a competitive market.
In the ever-evolving world of financial services, staying ahead means not only keeping costs under control but also masterfully optimizing profitability. It’s not simply about reducing expenses but understanding and implementing strategies that promote sustainable financial health and growth. Micah Campbell, with 18 years of experience at Armada Consulting, elaborates on this nuanced approach to cost and performance management in the finance sect
 

Introducing Profitability and Cost
Management Mastery

Micah and his team at Armada Consulting have carved a niche in the financial services industry, helping clients transform their approach to cost management into robust profitability and performance strategies. Since narrowing their focus in 2008, they have become synonymous with expertise in the financial services cost management space.
 

A Focus on Financial Services

This specialization is no accident. Recognizing early on where their strengths lay, Armada decided to channel all its efforts towards financial services. This decision was backed by a clear understanding of the industry’s unique challenges and needs, setting the stage for innovative solutions tailored to these complex environments.
 

Beyond Cost-Cutting: Envisioning
Holistic Profitability

The shift from traditional cost-cutting to comprehensive profitability management is pivotal. Armada Consulting doesn’t just look at ways to reduce expenses; their ethos involves a holistic assessment of financial operations to pinpoint areas for improvement that go beyond mere cost control. This approach not only helps in identifying inefficiencies but also in uncovering opportunities for enhancing revenue and sustainable growth.
 

Insights from the Frontline

Having worked with multiple top 10 US banks, the experience Micah brings to the table is nothing short of invaluable. Implementing various cost and profitability management strategies, alongside reporting analytics, has provided Micah with a deep understanding of what works. This frontline experience is a testament to the effectiveness of their methodologies in the real world of finance.
 

The Path Forward: Embracing Comprehensive Cost and Performance Strategies

For financial institutions looking to stay competitive and profitable, revisiting their approach to cost and performance management is essential. With insights from Armada’s extensive experience, firms can begin to see cost management not just as a necessity but as a strategic advantage. Looking at the bigger picture, it’s about making informed decisions that foster long-term profitability and performance excellence.

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]]> Uncover the Hidden Costs of AI: A Bank’s Journey https://www.costperform.com/uncover-the-hidden-costs-of-ai-a-banks-journey/ https://www.costperform.com/uncover-the-hidden-costs-of-ai-a-banks-journey/#respond Thu, 30 May 2024 14:03:51 +0000 https://www.costperform.com/?p=16330 Learn how a bank uncovers the hidden costs of AI, using advanced cost calculation techniques to prevent overruns and ensure successful AI implementation.

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]]> Artificial Intelligence (AI) offers great promise for the finance sector. It can increase efficiency, improve decision-making, and enhance customer experiences. At the recent Gartner CFO Conference, the opening keynote speakers Nisha Bhandare & Clement Christensen highlighted setbacks and stalling in four key areas: regulatory compliance, technological integration, workforce adaptation, and, notably, the escalating costs of AI.

To illustrate the costs of AI, consider the journey of a mid-size bank implementing AI to personalize customer service. This hypothetical scenario, informed by insights from the Gartner conference, leverages advanced cost calculation techniques to overcome these challenges effectively.

“Cost is one of the greatest (near term) threats to the success of AI and generative AI. More than half of the organizations are abandoning their efforts due to missteps in estimating and calculating costs.”

Gartner, 2024

The Initial Excitement and Rollout

Our bank, eager to enhance customer service, decided to implement an AI-driven system for personalized interactions. The initial excitement was palpable; the potential benefits were clear. However, the bank decided not to construct its own large language models but instead acquire an existing service. Yet, the initial rollout quickly revealed substantial costs. Software acquisition, infrastructure setup, and hiring skilled personnel all required significant investment.

Centralizing implementation and vendor management helped handle these initial costs effectively, streamlining the rollout process and reducing redundancy. Cost allocation models distributed the setup costs accurately across various departments, ensuring transparency and accountability. (fig 1: AI Cost Categories, “AI Services (Labor/People)”)

The Rise of Ongoing Usage Costs of AI

As the AI system integrated into daily operations, a new challenge emerged: ongoing usage costs of AI. Unlike traditional technologies, AI’s operational expenses increase with usage. More employees utilizing the system and the rising volume of data processing led to escalating computational costs. As the AI system processed more customer interactions, the bank saw its data processing costs increase by 20%, resulting in an additional $600,000 in annual expenses.

Advanced cause and effect cost modeling allowed the bank to simulate various usage scenarios and forecast future costs. This proactive approach helped the bank prepare for and manage these expenses, preventing budget overruns and protecting the expected return on investment. (fig 1: AI Cost Categories, “I&O/Compute/Cloud”)

For a deeper understanding of how cost and profitability modeling can enhance financial communication and performance, refer to our article on The Role of Cost and Profitability Modelling in Communicating Financial Performance.

AI Experimentation and Its Financial Implications

AI’s journey is rarely straightforward. Continuous experimentation is necessary, and our bank faced several costly iterations while refining the personalized customer service system.

Initial attempts had mixed results, leading to many expensive adjustments. For instance, the bank spent $500,000 on decentralized pilot projects that did not meet performance standards. These failures were part of the learning curve, but they also represented significant sunk costs. Managing all the decentralized, isolated pilots proved crucial.

By employing detailed cost allocation methods, the bank tracked and managed these experimental expenses. This granular approach ensured that each experiment’s financial impact was clear, aiding in better decision-making and resource allocation.

Visualizing these costs of AI helped identify the areas where AI expenses were most significant, allowing for targeted improvements. For example, the bank identified that 30% of the overrun costs were due to inefficient data processing algorithms, which required optimization. (fig 1: AI Cost Categories, “AI Software/Tools/Platform” and “Human Talent & Process”)

Strategic Refocus on AI Investments

Realizing the need for a strategic approach, the bank shifted from running isolated AI pilots to aligning AI investments with broader strategic priorities. Treating AI initiatives as a portfolio of projects allows the bank to focus on efforts that directly contribute to profitable growth and customer satisfaction.

This alignment ensures that resources are directed towards high-impact areas, maximizing the overall benefit of AI investments. By integrating cost calculation models that visualize the cause-and-effect relationships between different investments, the bank could better understand the long-term financial implications of each AI project. As Gartner points out, “Achilles Heels: Costs Can Go Awry by 500%-1,000%,” highlighting the importance of accurate cost estimation and strategic planning.

“Costs Can Go Awry by 500%-1,000%”

Gartner, 2024

Practical Example: Managing the Costs of AI for Personalized Customer Service

Consider the AI-driven personalized customer service project. The initial costs included acquiring sophisticated AI platforms at $2 million and extensive staff training at $500,000. Managing these costs required a comprehensive understanding of each expense component. As the system processed increasing volumes of customer interactions, ongoing usage costs surged. Within the first six months, data processing costs increased by 20%, adding $600,000 to operational expenses.

Advanced cost simulations helped the bank forecast these costs of AI and plan accordingly, ensuring they stayed within budget. During the experimental phase, several iterations failed to meet performance standards, leading to additional expenses of $300,000. However, tracking these costs meticulously allowed the bank to learn from each failure and improve subsequent models.

Accurate cost estimation proved critical. Continuous model updates and compliance with evolving regulations added layers of complexity, costing an additional $200,000 annually. By visualizing cost flows, the bank could identify unexpected cost drivers, such as higher-than-anticipated computational requirements or data storage needs, which added another $150,000 to the budget. This clarity enabled more precise budgeting and ensured that the AI project remained financially viable. (fig 1: AI Cost Categories, “AI-Ready Data”)

For example, the bank discovered that 25% of the cost overruns were due to inefficient use of cloud storage services. By identifying this root cause, the bank was able to optimize their data storage strategy, ultimately reducing these costs by $100,000 annually.

Costs of AI: Categories and Mitigation Strategies

The following table outlines various cost categories associated with AI, based on Gartner’s categories. We have elaborated on these categories, providing concrete examples of typical costs involved, their impact on the budget, and potential mitigation strategies:

Cost Category
Description
Typical Costs Involved
Impact on Budget
Mitigation Strategies
Risk Management
Costs related to identifying, assessing, and mitigating risks associated with AI implementation.
Risk assessments, compliance audits, insurance premiums
High if risks are not managed
Regular risk assessments, compliance training
Environmental
Costs associated with the environmental impact of AI infrastructure and operations.
Energy consumption, cooling systems, carbon offset programs
Moderate to high
Energy-efficient hardware, renewable energy sources
AI Services (Labor/People)
Costs for hiring and retaining skilled personnel to develop, implement, and maintain AI systems.
Salaries, training programs, recruitment costs
High due to demand for AI talent
Continuous learning programs, competitive compensation
I&O/Compute/Cloud
Infrastructure and operational costs, including cloud services, hardware, and data centers.
Cloud storage fees, server costs, networking infrastructure
High, especially with scale
Optimize usage, negotiate with cloud providers
AI Software/Tools/Platform
Costs for acquiring AI software, tools, and platforms required for development and deployment.
Licensing fees, subscription costs, integration expenses
Moderate to high
Evaluate ROI of software, leverage open-source tools
Human Talent & Process
Costs related to the processes and workflows needed to support AI initiatives, beyond direct labor costs.
Process optimization, change management, collaboration tools
Moderate
Streamline processes, invest in process automation
AI Governance & Security
Costs for establishing and maintaining governance frameworks and security measures for AI systems.
Security audits, governance frameworks, regulatory compliance
High due to stringent requirements
Implement robust governance and security frameworks
AI-Ready Data
Costs for preparing and managing data to be used effectively in AI models, ensuring it is clean and reliable.
Data cleaning, data integration, data storage, data annotation
High if data quality is poor
Invest in data management tools, ensure data quality
Fig 1: AI cost categories associated with AI, based on Gartner, 2024

Ensuring AI Cost Transparency and Profitability

AI presents both opportunities and challenges for the finance sector. Our bank’s journey, informed by insights from the Gartner CFO Conference, highlights the importance of managing hidden costs of AI. By employing advanced cost calculation techniques, the bank uncovered hidden costs, optimized investments, and ensured sustainable AI adoption. This proactive and strategic approach enabled the bank to achieve greater cost transparency, enhance profitability, and make informed decisions, driving sustained financial health and competitive advantage in the dynamic financial landscape.

CostPerform is the ideal software for this process. Its advanced cost calculation capabilities, intuitive interface, and powerful visualization tools enable organizations to manage costs at a very granular level. This includes understanding the drivers behind AI implementation costs and calculating the resulting costs per department, per product, per channel, or even per client.

By uncovering hidden costs, optimizing resource allocation, and providing clear insights into cost drivers, CostPerform helps financial institutions manage AI adoption and achieve their goals. For any organization looking to harness the power of AI while maintaining financial control, CostPerform offers the tools and expertise necessary to succeed.

Source: Highlights From Gartner CFO & Finance Executive Conference

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]]> https://www.costperform.com/uncover-the-hidden-costs-of-ai-a-banks-journey/feed/ 0 How Banks Navigate the Complex Landscape of Cost Management https://www.costperform.com/how-banks-navigate-the-complex-landscape-of-cost-management/ Thu, 30 May 2024 13:59:06 +0000 https://www.costperform.com/?p=16305 In the banking industry, understanding the profitability of banks is not as straightforward as it is in manufacturing.

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Key Takeaways

  • Controlling costs in banking and financial services is critical for maintaining profitability.
  • The three main types of costs to manage are default risk, the cost of capital, and operational costs.
  • Operational costs, while often deemed controllable, significantly impact a bank’s efficiency and profitability.
  • The dynamics of default risk and cost of money are influenced by external market factors, making them harder to predict and manage.
  • Effective use of profitability models helps banks measure and manage costs, especially operational ones.
Banks and financial institutions continually seek ways to maintain and enhance their profitability. An essential strategy in achieving this goal lies in effective cost management. Different types of costs impact a bank’s financial health, each with its intricacies and management challenges. This post delves into the three critical costs banks and financial services should control: default risk, the cost of capital, and operational costs. Understanding and managing these expenses is vital for any bank’s success.

Default Risk: An Uncontrollable Concern

Default risk embodies the danger of loan recipients failing to meet their repayment obligations. This risk significantly concerns banks as it directly impacts their bottom line. Market factors largely influence default risk, rendering it somewhat out of a bank’s immediate control. Post-pandemic, the instability in the retail and commercial sectors has augmented this risk, manifesting in increasing vacancies and potential loan defaults on commercial properties. Banks need to understand their exposure to this risk and implement measures to proactively manage potential impacts on profitability.

Cost of Capital: The Market’s Grip

The cost of money, or the cost of capital, is another substantial expense for banks. This cost is intricately linked to the interest rates set by the Federal Reserve and the market-driven yield curves. These elements dictate the price banks pay for the money they then lend out. Like default risk, external market factors largely control the cost of capital, adding a layer of complexity to its management. Banks strive to forecast these costs and adjust their strategies accordingly, though the unpredictable nature of market factors poses a perennial challenge.

Operational Costs: The Controllable Factor

Operational costs represent the expenses associated with the day-to-day functioning of a bank. Unlike default risk and the cost of capital, operational costs are within a bank’s control. From staffing levels to technology investments, banks can adjust these expenditures to enhance efficiency and, ultimately, profitability. The transition from branch-based to digital operations illustrates a significant area of operational cost management, potentially offering substantial savings and efficiency improvements.
Operational costs indeed matter a lot, despite some perceptions to the contrary. They encompass a broad range, from the direct costs of running a physical bank branch network to the investments in digital banking platforms. While branches require substantial staffing and real estate resources, digital operations bring their own set of costs, including software licensing and development. Crucially, banks have developed sophistication in tracking and managing these costs, applying detailed metrics and profitability models to ensure efficiency.

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]]> Unlocking Profitability in Banking: A Comprehensive Guide https://www.costperform.com/unlocking-profitability-in-banking-a-comprehensive-guide/ Thu, 30 May 2024 13:32:20 +0000 https://www.costperform.com/?p=16311 In the banking industry, understanding the profitability of banks is not as straightforward as it is in manufacturing.

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Key Takeaways

  • Understanding Product and Customer Profitability: Identifying the most profitable products and customers can significantly enhance a bank’s performance.
  • The Role of Digital Channels: Digital banking channels often offer greater profitability but require a nuanced understanding of customer needs and behaviors.
  • Branch Rationalization: Optimizing the mix of physical and digital banking services is crucial for maximizing profitability and customer satisfaction.
  • Employee Performance Impact: The success of relationship managers and personal bankers is key to building a profitable customer base and effective cross-selling.
  • Customer Experience: Keeping the customer experience at the forefront of strategy can prevent the loss of clientele and ensure sustained profitability.
In today’s competitive financial landscape, banks are continually seeking ways to enhance their profitability. But what does this entail from a banking perspective? This blog post delves into the critical elements that banks must consider to remain profitable, offering a guide on how to navigate the complexities of the banking sector profitably.

The Critical Elements of Bank Profitability

1. Identifying Profitable Products and Customers

At the heart of banking profitability lies the ability to distinguish which products and customers contribute the most to the bottom line. This involves analyzing product performance in detail and understanding the characteristics of profitable customers. By targeting the right customer segments with tailored products, banks can improve both cross-selling opportunities and overall business growth.

2. Digital vs. Physical Channels: Striking the Right Balance

The debate between the profitability of digital banking channels versus traditional brick-and-mortar branches is ongoing. While digital channels can offer higher profitability margins due to lower operational costs, they require a deep understanding of customer preferences and behaviors. Moreover, the physical presence of branches plays a crucial role in building trust and providing personalized services. The challenge for banks lies in finding the optimal mix of digital and physical channels to meet customer needs effectively.

3. The Importance of Employee Performance

The performance of bank personnel, especially relationship managers and personal bankers, is a significant determinant of profitability. These employees are on the front lines, building profitable customer bases through effective cross-selling and service delivery. By harnessing the insights and best practices from top performers, banks can train their staff to replicate this success, thereby enhancing overall profitability.

4. Prioritizing Customer Experience

In the end, the success of any bank’s profitability strategy hinges on customer experience. This encompasses everything from the convenience of digital channels to the personal touch provided in branches. Banks must continually assess and adapt their services to meet customer expectations, ensuring that each interaction contributes to a positive and engaging customer journey.

Conclusion

Profitability in banking is not a one-size-fits-all formula but a complex interplay of understanding customer and product profitability, optimizing channel usage, leveraging employee performance, and prioritizing customer experience. By focusing on these core elements, banks can navigate the challenges of the modern financial landscape and secure their profitability for the future.

The post Unlocking Profitability in Banking: A Comprehensive Guide first appeared on CostPerform.

]]> Is Change Management the Silent Killer of Profit in Banks? https://www.costperform.com/is-change-management-the-silent-killer-of-profit-in-banks/ Tue, 12 Mar 2024 14:46:59 +0000 https://www.costperform.com/?p=13031 In the banking industry, understanding the profitability of banks is not as straightforward as it is in manufacturing.

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Key Takeaways

  • The profitability of banks is driven by capital costs and operational costs.

  • Capital costs, which banks cannot influence, include the cost of acquiring money to lend and the cost of maintaining cash reserves.

  • Operational costs, which banks can control, include the costs of granting and servicing loans.

  • By understanding and managing operational costs, banks can improve their profitability.

  • Evaluating default risk is a significant operational cost that banks should account for.

In the banking industry, understanding the profitability of banks is not as straightforward as it is in manufacturing. While manufacturing operates on a margin basis, considering the cost of goods sold and revenue, banking is a bit more complex. It isn’t as simple as calculating a margin. The two main drivers of a bank’s profitability are the capital cost and the operational cost. In this article, we will delve into these aspects and explore how banks can manage these costs to improve profitability.

Understanding Capital Costs

Capital cost is a significant factor in a bank’s profitability. It is measured in two parts. One part is the cost of acquiring money to lend out. Suppose a bank can acquire money at a rate of 4% for ten years and grants a mortgage at 3.1%. In this case, the bank has a 0.9% margin. However, having a mortgage on the balance sheet incurs a capital cost due to regulatory requirements on cash reserves. These two aspects make up the capital costs that a bank cannot influence.

The Role of Operational Costs

While capital costs are mostly uncontrollable, the operational costs involved in granting a loan, which are primarily administrative, are within the bank’s control. These costs include the entire loan approval process, opening accounts, checking documents, and assessing the creditworthiness of the borrower.

There are also costs associated with servicing the loan, such as addressing changes in the borrower’s life circumstances, handling inquiries, and managing the loan account. Understanding and managing these operational costs is crucial for a bank’s profitability.

Measuring Operational Costs

Banks measure operational costs by breaking down the activities involved in granting and servicing a loan. For instance, the process of granting a loan involves checking documents, going through credit committees, and various other activities leading to the loan approval.

Each of these activities has associated costs. By measuring these costs at different stages and across different departments, banks can gain insights into their profitability. This approach allows banks to understand the cause-and-effect relationship between activities and costs, leading to more effective cost management.

Evaluating Default Risk

Another significant operational cost for banks is evaluating the default risk. Banks use sophisticated risk models to calculate the chance of default based on various parameters. The cost of updating and maintaining these models is a part of the operational cost that should be accounted for in the bank’s bottom line.

In conclusion, while capital costs are a significant part of a bank’s expenses, the only controllable profitability lies within the bank’s operational costs. By understanding and managing these costs, banks can improve their profitability and avoid the silent killer of profit – poor change management.

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]]> The Hidden Costs in Banking: A Guide to Uncovering and Managing Them https://www.costperform.com/the-hidden-costs-in-banking-a-guide-to-uncovering-and-managing-them/ Wed, 14 Feb 2024 09:51:19 +0000 https://www.costperform.com/?p=14641 Discover how banks uncover and manage hidden costs through cost modeling techniques, leading to effective cost management and profit realization.

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Key Takeaways

  • Banks can uncover hidden costs through cost modeling.
  • Direct cost method serves as a basic way to track costs to products.
  • The activity-based costing method offers a more sophisticated approach.
  • Time-driven activity-based costing incorporates time and capacity.
  • Multidimensional costing combines product and client for different costs.
  • Understanding all these elements leads to profit line realization.
The banking industry, like others, is often confronted with the challenge of uncovering and managing hidden costs. This task, while not unique to banking, requires specific strategies to effectively address it within the context of the industry.

The Art of Cost Modeling

Cost modeling serves as the primary tool for understanding the cost structure within a bank. This involves tracing the costs from the general ledger down to the products, essentially answering the question: How do the costs end up at the product level?

The Direct Cost Method: Limited Choice for Banks

The first approach to this is the direct cost method, a simple calculation that attempts to attribute costs directly to a product. This method, while effective in industries like manufacturing, has its limitations in a banking context. For instance, the cost of a credit card is not merely the plastic it is made from.

The Activity-Based Costing Method: A Sophisticated Approach

To address these limitations, banks often employ a more complex method known as activity-based costing. This method traces costs from the general ledger to resources, then to activities, and finally to products. It starts with allocating costs to the most important resources, activities, and products, usually in percentages.

Time-Driven Activity-Based Costing: Adding a Time Element

As cost modeling becomes more sophisticated, banks begin to incorporate actual numbers rather than percentages. This leads to the concept of time-driven activity-based costing, where the time spent on a certain activity and the required capacity for that activity are considered. This method allows for better cost management.

Multidimensional Costing: The Intersection of Product and Client

The final level of sophistication in cost modeling is multidimensional costing. This method acknowledges that the same product can have different costs depending on the customer type and other variables. Thus, the combination of product and client creates different costs, providing a more nuanced understanding of the cost structure.

The Bottom Line: Profit Realization

By understanding these various elements and how they interact, banks can uncover their hidden costs and manage them effectively. This leads to the profit line, the goal of any business, including banks.

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