What Bank Business Lines Will You Invest In?

Bank Capital Allocation Strategy

If you have an MBA or have any corporate strategy training, undoubtedly you have been exposed to the famous Boston Consulting Group’s Boston Matrix. McKinsey & Company promoted their version of it and Jack Welsh at General Electric made it an art form. The framework is used by many banks today and charts each line of business along the twin dimensions of growth potential and market share. The problem is, this framework can get a community bank in trouble. As we approach strategic planning season, every bank needs to make business line decisions when allocating risk and capital. If you are interested in a better framework, then this post might stimulate some new thinking.


The Boston Matrix


Before we tackle a new construct, first some background of the classification of the traditional Boston Matrix.


  • Stars: These are lines of business that are profitable and that have high growth potential. Commercial lending, for example, with the huge amount of loans that are in refinance territory, fall into this category.
  • Cash Cows: These are businesses that have limited potential but have products that generate solid cash flow. Overdraft protection is a classic bank example.
  • Question Marks: The business lines have potential but have low market share and have not lived up to their potential. Bankers need to either invest or expand these business lines. Trust services and wealth management often fall into this category for many banks.
  • Dogs: The lines have minor cash flow and limited potential. The business lines should be shut down or sold.


A matrix for a typical bank is diagramed below: 


Bank Growth Market Share Matrix


The Matrix Problem


The problem with the matrix is that ignores some key elements such as risk, synergies and culture. A mortgage division is not (or should not be) a standalone entity at a bank. Cross-sell, upsell, retention and the cultural of being able to refer a valued customer internally all must play a role in the capital and risk allocation decision.  Treating a mortgage operation as a separate business line undervalues the business and leads to poor allocation decisions.


Conversely, a highly performing business line may get more capital without the recognition that a tangential business may provide a higher return. For example, investing in streamlining loan processing not only helps improve margins for commercial, retail and SBA, but also assists with the synergies between these lines.


There is also the misguided focus of market share for community banks. It is likely that in most business lines a community bank’s market share may be in the low single or double digits. This level of penetration makes market share largely irrelevant.


The People Problem


A bank’s highest cost is its people and is a bank’s most valuable assets. Treating business lines just by the earnings numbers and by their net present value (as indicated by the size of the circle above), robs managers from the ability to invest in people. Decisions get made irrespective of culture and regardless of personal future talent development. 


While good people in a bad business is no reason to keep the business, human capital isn’t instantly fungible.  Sometimes, “parking” talented employees in a less than high growth business is the only way to keep them engaged for the short-term until a position with greater potential opens up.


Revising The Framework


Bank management adds value by creating synergistic energy. Otherwise, a business should be divested. Unfortunately, few banking schools teach how to approach bank strategy when it comes to deciding which business lines to enter and when, when to sell or shut down a business line and how to allocate both risk and capital across the portfolio of business lines.


To revise the Boston Matrix, we have made a couple adjustments for the community bank strategic purpose. The overarching goal is to visually revise the matrix so that it places more emphasis on synergies so banks can understand and focus on what these business lines contribute to each other.


For starters, we turned the framework into a circular shape with the center representing more synergies among departments. This makes more logical sense and gives a better graphical representation of a core focus. The closer to the center a business is, the more the business is needed for core banking operations.


Out is the terminology of “dogs” and “cash cows.” No one likes to be milked or be analogous to a laggard. Terming businesses in this manner, we have found, has a detrimental impact on morale.


We sized the products on a risk-adjusted return basis so that a correlation can be seen. Smaller circles might be large revenue producers, but small income producers relative to risk.


Business lines were then color coded so that those that have more links, more contributors to other departments are colored green, while those that are more standalone operations are yellow. Completely standalone entities can be colored red. In future blog posts, we will talk about a “contribution score” but it is how many other products lines does this product touch.


Finally, the spatial relationship within the circle is such that the more core businesses are in the center, while a business that doesn't add synergistic value, don’t present a sizable return or don’t have future growth opportunities move to the outside. 


Making Bank Capital Allocation Decisions


Putting This Into Action


 We have found a graph similar to the above to be more useful when talking about strategic decisions among business lines. It helps keep the board and the management team’s focus on issues that matter – risk-adjusted profitability, contribution to other business lines and strategic importance.


For banks involved with M&A, having this type of diagram and then looking at your target in this manner helps have a discussion on the value of the joint synergies.


This diagram is work in progress, and we are constantly looking for ways to improve our graphic depiction of the key elements of business line management. Hopefully, this may provide your bank with a better construct on how to make business line risk and capital allocation decisions in order to better grow your bank along successful strategic dimensions.