# Calculating Customer Lifetime Value for Banks

### How to calculate customer lifetime value (CLV) for a bank

Having had a corporate background in banking, I found that customer lifetime value was a key marketing metric in the finance sector. This is because banks (and other financial institutions) will hold customers for a long period of time and the customers will go through phases of their relationship – ranging from highly profitable to minor (or even negative) profitability.

Banks tend to focus a considerable amount of their marketing efforts on trying to build more profitable relationships with existing customers. Essentially direct marketing and relationship marketing efforts are used to:

1. Retain the loyalty of the customer (greater customer lifetime in years)
2. Increase the value/profitability of the customer (through up-selling and migration to higher value products).

The ROI on the investment in the various direct and relationship marketing efforts can be measured quite effectively using a customer lifetime calculation. To assist in this CLV calculation for a bank, a free customer lifetime value Excel template has been provided on this site.

### The customer lifetime value calculation for banking

Customer lifetime value is calculated primarily the same way for a bank as it is for the main CLV calculation. Please refer to additional information on this website as required – please navigate by the above menu.

The key inputs into the customer lifetime value (CLV) banking calculation include:

• Average balances of loans and savings on a per customer basis
• Average interest rate margin (as a percentage)
• Average income/revenue per customer generated from non-interest income sources (e.g. fees, commissions, and other sales)
• Costs of providing customer services and access (which would include transaction costs, statement costs, and potentially a provision for infrastructure costs, and so on)

These inputs are used together to determine average annual profit on a per customer basis. This information is then combined with customer retention rates, other costs of retention and up selling, as well as initial customer acquisition costs – to determine the customer lifetime value (CLV) for the bank.

#### How average interest margin is used in the calculation

The customer lifetime value formula has been discussed elsewhere on this website, and probably the most significant difference for the banking customer lifetime value calculation is the handling of the interest rate margin in the determination of CLV.

If you look closely at the free Excel template of the CLV banking calculation, you will note that the profit generated from the average balance multiplied by the interest rate margin is then divided by two. Why is this necessary?

It is necessary to ensure that profits are not double counted in the calculation of customer lifetime value (CLV). As we know, banking involves the matching of depositors and borrowers – so let’s look at the following simple example.

##### Simple CLV Banking Example

Let’s assume we have just two banking customers (in order to make the calculation straightforward). The first customer has \$10,000 in a savings account at 6% pa interest and the second customer has a loan for \$10,000 at 10% pa interest.

In simple terms, our net interest margin is 4% (10% less 6%). Assuming interest only repayments, the bank would generate \$1,000 in interest revenue from the borrower and then pay \$600 in interest expense to the depositor. This is a \$400 per annum profit for the bank, which is equivalent to our 4% net interest rate margin.

However, because there are two customers involved, this \$400 profit amount needs to be divided by the two customers. This means that each customer helps generate \$200 in profitability.

Therefore, this is why the interest income is divided by two in the customer lifetime value calculation.

#### Totaling Savings and Loan Balances

Because of the manner in which the spreadsheet handles the CLV calculation for a bank, it is then a simple manner to take the bank’s total loans and total deposits and add them together to determine the total combined portfolio. This total portfolio can then be divided by the total number of customers to calculate average balance, as shown in the following example.

• Bank’s total loans = \$400m
• Banks’s total deposits = \$600m
• Added together = \$1b total portfolio
• Bank’s customer base = 50,000 customers
• Can then calculate average balance \$1b/50,000 (total portfolio/number of customers) = \$20,000 average balance per customer

This simple approach ensures that all balances from all customers are included. For example, say a customer had \$1,000 in savings and a \$1,000 loan – then this approach would count \$2,000 in their average balance – say at a 4% net interest margin (see above), then divided by two = \$2,000 X 4% / 2 = \$40 per year profit contribution.

### Determining Net Interest Rate Margin

This is normally a key financial metric for a bank so it should be easy to find in their annual reports, but a simple way to calculate it is:

• Net interest income/average total assets for the year

Posted on Categories banking