Blending Ratios in the Variable Business: Optimal Design of Cash Flow and Margin for Phasing-Out Liability Products

Classification and Objectives

Many institutions in the variable deposit business face a dual challenge: on the one hand, stable and adequate margins must be achieved; on the other, the product landscape and management logic must remain manageable. Historically grown product portfolios – frequently supplemented by individual special conditions – make consistent management of the liability side considerably more difficult.

Against this backdrop, the targeted design of blending ratios (BRs) as a central steering parameter is gaining increasing importance. In particular, when dealing with phasing-out liability products, targeted positive effects with regard to cash flows, margins, and process effort can be realised.

Advantages of a Well-Structured Product Catalogue

A clearly structured product catalogue forms the basis for effective overall management. The key is a clean separation between actively sold products and those that are merely being “managed” as they phase out. These so-called “legacy products” remain available to customers but are no longer actively marketed or priced.

A reduced set of actively offered products creates a clear sales focus whilst simultaneously reducing the need for customer-specific arrangements. This not only lessens the risk of cannibalisation effects between similar products, but also leads to a marked reduction in special conditions.

From a controlling perspective, there are additional advantages: phasing-out products can be assessed in a standardised manner and generate considerably less effort during regular parameter reviews with respect to blending ratios.

Handling Phasing-Out Liability Products

If the strategic decision is made to discontinue the active distribution of a product whilst simultaneously keeping the interest rate sustainably low, this results in a specific representation within the management framework.

By extending the blending ratio as a deliberate parametrisation, it is ensured that the stable, albeit prospectively declining, volumes of these products are adequately considered in the maturity transformation. At the same time, the combination of a low customer interest rate – independent of market rates – and longer replication maturities typically leads to increased margin contributions.

Such a design is, however, subject to a duty of justification and must be made plausible both in terms of the model and with regard to the regulatory rationale. To this end, the effects of declining volumes must be systematically analysed, and their impact – particularly on margins, cash flows, and compensation payments – must be made transparent.

Streamlining Processes in the Ongoing Review of Blending Ratios

Once a blending ratio has been soundly derived and documented, the operational effort involved in parameter validation in subsequent years is significantly reduced. The ongoing review is essentially confined to two questions:

• Is the intended interest rate policy being adhered to in practice?
• How is the portfolio volume developing over time?

In particular, the consistent avoidance of special conditions in these “legacy products” plays a central role here, as these can undermine the defined structure of the blending ratio. Monitoring the volume development simultaneously provides a necessary input for profit and loss forecasting and is therefore already an inherent part of the ongoing management process.

Satisfied Customers Without Special Conditions?

One of the greatest challenges is meeting rising customer expectations whilst maintaining a restrictive interest rate policy. Phasing-out products with low interest rates inevitably give rise to advisory discussions. And this can be turned to the bank’s advantage!

The solution does not lie in granting individual special conditions for these “legacy products” but – should the customer proactively approach the bank – in customer-oriented advice based on the current product catalogue.

In this way, the management logic remains intact whilst ensuring a customer-focused advisory approach at the same time.

Concluding Remarks

The foundation for sound management of the variable business is therefore a consistently maintained and actively managed product catalogue on the liability side. The demarcation of “legacy products” from the active product range represents an effective instrument for optimising cash flows and margins. The consistent avoidance of special conditions leads to more precisely calibrated blending ratios in the context of interest rate risk, and thus to qualitatively improved results in risk measurement.

Through the combination of extended replication assumptions, fewer special conditions, and lower interest rates, higher margins can typically be achieved within the portfolios of “legacy products”.

At the same time, the systematic decline in volumes means that the corresponding amounts must be absorbed by actively managed products. Assuming that the loss of special conditions in “legacy products” and market-rate-aligned interest rates in target products broadly offset one another, the net result is a positive earnings contribution through the margin expansion in the portfolio.

This effect is further complemented by significantly simplified validation processes, as the focus is directed towards a smaller, clearly defined set of products.