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Wednesday, May 25, 2011

How banks are copying supermarkets via 'loss leaders'

Any visitor to supermarkets would have noticed that they sell certain staples cheap to attract footfalls, which will hopefully result in selling more profitable merchandise. Even in that notoriously zero NPV world of banking, this does happen to be true, as the examples below show
  1. Investment banks in India routinely take a pittance(less than $1) to advice on marquee public sector capital issuance. Why? One reason is that they value their place on the league tables, second is that this will give them an 'in' with that issuer for future business. 
  2. To attract broking clients, several banks sell the benefits of their 'platform' with thin spreads, quick service etc. In the most liquid markets/currency pairs, banks may even lose money on a standalone basis. But they hope to make up for that via block trades, structured deals etc. 
  3. For getting the high margin(because once infrastructure costs are borne contribution is nearly 100%) transactional business like cash management etc, banks do agree to competitively price their loans to clients, give covenant lite loans etc. And that is needed because unlike the banking services where there is competition only from other banks, lenders face competition from alternate capital provides including suppliers, customers, Governments, equity markets etc.
In retail banking, this used to be the case via zero balance accounts, free credit cards etc. But given the cost cutting spree in retail banking off late, these perks(specially in the developed nations) are fast becoming a thing of the past. Now unless the regulator mandates universal banking, the retail products pricing is typically activity based costing related, and not that much predicted on future potential. Thankfully, India is still an exception when it comes to PSU banks, but private banks like ICICI/HDFC/Axis are already going the Western way.

So next time you notice a bank apparently 'losing money', stop and ask yourself what you are missing? Remember they employ very smart people(who CAN make mistakes but those are rare), and so maybe the benefits are not visible to you upfront.

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