Key Takeaways
- The main cost drivers for banking products are expected losses, cost of funding, and operational cost.
- Banks are increasingly trying to capture operational costs at a granular level, even on a transactional basis.
- The data for expected loss and cost of funding comes from the risk and treasury departments respectively.
- The rhythm of these cost drivers varies – cost of funding changes daily or hourly, operational costs change monthly or quarterly, and expected losses are analyzed at least monthly.
- Profitability models can be run multiple times a day or month, depending on the bank’s needs.
When it comes to banking, one question that often arises is: what are the main cost drivers for banking products? In my experience, primarily within the retail lending sector, these can be broadly classified into three categories: expected losses, cost of funding, and operational cost.
Operational Cost: The Backbone of Banking
Operational cost is where I’ve spent most of my career, modeling these costs for various organizations, particularly in banking. These costs can be modeled in different ways – they can be very granular or not so granular, capacity aware or not, multidimensional or single dimensional. In recent times, banks are striving to capture operational costs as granularly as possible, even on a transactional basis.
Expected Losses: A Key Cost Driver
Expected losses form a significant part of the lending business. After all, any loan that a bank cannot recover translates into a cost. Various models are used to calculate expected losses, typically driven by the risk departments within banks. The data for expected loss always comes from these departments.
Cost of Funding: A Constantly Changing Factor
The cost of funding is another major cost driver, with data coming from the treasury department. Unlike operational costs, which usually change monthly or quarterly, the cost of funding can change daily or even hourly.
Managing Profitability in Banks
An interesting aspect of these cost drivers is their rhythm. While the cost of funding changes almost every hour, operational costs change once a month or quarter. Expected losses are evaluated at least once a month. The frequency of running profitability models depends on whether they are used for setting pricing or determining the bottom line of the bank.
In conclusion, the main cost drivers in banking – expected losses, cost of funding, and operational cost – each have different suppliers and timing. Understanding these drivers is crucial for managing profitability in banks.
