Revenue Per Dollar of Risk
Price every unit of risk by the total revenue it drags in, then shrink what underpays.
- Difficulty
- Moderate
- Time to result
- ~months to results
- Steps
- 6
- Confidence
- 85%
The mechanism converts credit exposure from a volume metric into a yield-on-risk metric. For each relationship you carry, decompose revenue into net interest income from the loan and everything else the relationship produces: payments, treasury services, capital markets. A book skewed toward loan income is one being paid little for the risk it holds; a book skewed toward ancillary revenue is being paid properly. You then act on the measurement in both directions: reprice or exit relationships that underpay, and give the risk function real authority to sell and hedge so the exposure can actually shrink. The prerequisite is honest marks, because an aggressively accounted book will report the underpriced exposure as profitable right up until the cycle turns.
Origin
Extracted from Acquired. Dimon describes applying it on arrival at Bank One in 2000, where he found more US corporate credit risk than Citibank carried.
Core principles
- 01Risk-conscious does not mean risk-free; it means correctly priced.
- 02A relationship that only produces loan spread is underpaying for the capital it consumes.
- 03You must be able to shrink the book, which means being able to sell and hedge it.
- 04Aggressive accounting can make an underpriced book look profitable for years.
- 05Measure the ratio at the relationship level, not the product level.
How to run it
- 1
Find the real exposure
Go through the book yourself rather than accepting the reported position. Dimon discovered Bank One carried more US corporate credit risk than Citibank, accounted for unbelievably aggressively.
Watch out Aggressive accounting means the reported picture and the actual exposure can diverge by a lot.
- 2
Mark it down and reserve honestly
Re-mark every loan, raise reserves to the marked level, and take the earnings hit immediately rather than amortising the recognition.
Pro tip Do this in your first months, when the losses are attributable to your predecessor and the credibility gain is largest.
- 3
Tell the board what you found
Present the revised position and the stress case together, including how much would be lost in a recession, before anyone else discovers it.
- 4
Measure loan income against ancillary revenue
Split each relationship's revenue into loan NII and non-interest revenue. The mix is the scorecard: heavy loan income means you are being paid little for the risk.
Pro tip Bank One's middle market book ran roughly 80 cents loan income to 20 cents other; by the JP Morgan merger it was about 40/60.
- 5
Give risk the tools to shrink the book
A risk leader who can only recommend cannot reduce exposure. Grant explicit authority to sell loans and to hedge, with a stated size limit.
Pro tip Dimon's hire accepted the role only after confirming she could sell loans, hedge loans, and do so in ten-billion size.
Watch out Without sale and hedge authority the only lever left is refusing new business, which is slow.
- 6
Reprice or exit the underpayers
Move relationships toward the target mix by adding services or repricing. Where neither works, let the exposure run off.
In the wild
Dimon found a middle market business where roughly 80 cents of every revenue dollar per relationship came from loan net interest income and only 20 cents from other services such as payments: a book being paid very little for substantial credit risk. He marked the loans down, raised reserves, hired a risk leader with explicit authority to sell and hedge up to ten billion, and shifted the mix. By the 2004 JP Morgan merger the split was approximately 40% loan income to 60% other revenue, and roughly $50bn of balance sheet had come out.
→ Recession arrived and the bank was, in his words, kind of okay by then, with United Airlines the one large loss.
Common mistakes
Hiring a risk officer without authority
A risk function that can only opine cannot reduce exposure. The mandate has to include selling and hedging, with a size limit large enough to matter.
Measuring per product rather than per relationship
Product-level P&L hides the point of the ratio, which is whether the total relationship pays for the credit risk the loan creates.
Running the analysis after the downturn starts
Selling and hedging exposure is cheap while markets function. The lesson from Bank One is that the repricing has to finish before the recession, not during it.
Is it for you?
Best for
Commercial banks and any business extending balance sheet or credit to win relationships.
Not ideal for
Businesses with no capital at risk per customer, where the relevant ratio is CAC to LTV.
From the transcript
“And risk-conscious does not mean getting rid of risk. It means properly pricing it and understanding the potential outcomes.”
“I went through every single loan in the books. I marked them all down, put up more reserves, told the board uh about it, and…”
“And one, you're being paid for the risk, and one, you're being paid little for the risk.”
From the episode
The Jamie Dimon Interview