Balancing the Scorecard : Beyond Cost Income Ratio in Agency Banking

In the grand theatre of banking, some actors stride onto the stage clad in heavy armor, risking their own fortunes for applause. Others, lighter on their feet, merely broker the spectacle earning their place without wagering their own wealth. Yet, when the curtain rises on performance metrics, both are judged by the same harsh spotlight : the cost-to-income ratio (CIR). But should they be?

The Domination of Ratios

For decades, CIR has been the darling of boardrooms and investor decks. A neat, single number that promises to reveal operational efficiency. Lower is better. A high CIR signals bloated costs, inefficiency, and managerial laxity. It is the ratio that whispers judgment in every review.

But like all dominations, this one thrives on oversimplification. CIR assumes that every dollar of income is born equal, and every dollar of cost is equally damning. It ignores the invisible weight or absence of capital deployed to earn that revenue.

The Two Worlds of Banking : PRINCIPAL and AGENCY

Banking is not monolithic. It is a dual universe:

• Principal Banking - The gladiator’s arena. Here, the bank deploys its own capital. Lending, underwriting, trading on principal books. Every move consumes regulatory and shareholder's capital, and every return must clear the high hurdle of cost of capital. (Which is equivalent to shareholder's minimum required rate of return.)
• Agency Banking - The nimble service provider with the sole purpose of earning fees in return of services provided. Here, the bank earns fees by distributing products, advising clients, calculating NAVs of funds they administer, providing safekeeping or settling transactions for external clients, or executing trades without taking positions on its own books. No capital is tied up. No balance sheet risk looms. That's also the reason why Agency Banking  is sometimes referred to as non-core.

The distinction is profound. Principal businesses are capital-intensive deploying shareholder's capital, whereas Agency businesses are capital-light. Whereas CIR treats them as equals.

Regulation Draws the Line too

The separation between principal and agency banking is not just a matter of business model, the regulators themselves have drawn a bold line on the stage. After the financial crisis, Europe rewrote its script. MiFID II and MiFIR insisted that activities done “on behalf of clients” must live in a different world from those done “on the bank’s own account.” The Liikanen proposals went further, warning that proprietary trading should not sit under the same roof as deposit-taking, lest risk spill from one room into another. 

Across the Channel, the UK’s Ring-Fencing rules formalised what the crisis had revealed. Principal-risk businesses and customer-asset businesses must not be entangled. They must stand on separate stages, each accountable for its own risks.

Then came FRTB, the Fundamental Review of the Trading Book. A rewrite of the market-risk rulebook so sweeping it felt like the regulators were raising the rent on every principal trading desk. Inventory would now cost more capital. Market risk would be priced more harshly. The trading book became heavier; the hurdle rate became higher. 

In effect, regulation itself acknowledges what CIR often ignores. These are two very different universes. One is built on capital, risk, and volatility. Whereas the other on service, scale, and stability. They were never meant to be judged by the same yardstick.

The Cost of Capital Lens

Here lies the crux - capital is not free. It carries an opportunity cost, which is the minimum return shareholders expect for the risk they bear. In principal banking, every dollar of income must exceed this cost of capital (the hurdle rate). A high CIR here is a red flag because it erodes the return on tangible equity (RoTE) and threatens value creation.

Agency banking, however, plays by different rules. With low to no capital deployed, the cost of capital is effectively zero. A high CIR may look ugly on paper, but it does not destroy shareholder value in the same way. The real question is therefore not “How low is your CIR?” but “How scalable and profitable is your fee income relative to operating costs?”. Or "How much is agency banking contributing towards cross selling of products or services that augments principal banking revenue?"

Beyond the Ratio

When we over rely on CIR as an universal metric, we risk misjudging agency businesses. Imagine a fund distribution arm with a CIR of 80%. Or a wealth advisory division with a CIR of 90%.

Alarming? 

Not if it generates steady fees, with negligible risk, zero capital consumption and cross selling opportunities.

Compare that to a lending book or a principal trading desk with a CIR of 60% but returns barely scraping past the cost of capital (investors required rate of return).

Which is truly efficient?

Efficiency is not a number, it is a narrative. One that must account for the invisible weight of capital.

The Call for Nuance

Banking is a business of trade-offs, not absolutes. Ratios are useful, but they are not gospels. In agency businesses, CIR should be a footnote, not a headline. Whereas in principal businesses, it remains a sentinel guarding against capital inefficiency. The next time we judge performance, let us ask not just “What is the CIR?” but “What is the cost of capital, and how does it create value beyond it?”

Because in the end, efficiency is not about numbers. It is about context. And context, like capital, is never free.

A Critical Question still remains: Who Pays for the Operating Costs of Agency Banking?

If Agency businesses do not consume the bank’s capital, how are their costs like technology platform licenses, run on infrastructure, people cost etc funded? The answer lies in the operating model. These costs could be initially covered by the bank’s overall income pool, which includes both principal and agency revenues. In essence, the principal side subsidizes the agency side, until SCALE is achieved.

This creates a strategic imperative. Is the agency model truly capital-light if its survival depends on capital-heavy businesses? Agency businesses must grow fees income fast enough to justify their share of costs, or risk becoming a drag on consolidated profitability. This raises a strategic question:

Being Capital-Light. Therefore is it a Myth or a Reality?

Technically yes, but strategically no.

• Yes, in regulatory terms: Agency businesses do not consume regulatory capital because they do not take credit or market risk. They remain capital-light from a compliance and risk-weighted asset (RWA) perspective.
• No, in economic reality, if agency businesses rely on principal revenues to cover costs. They indirectly depend on capital-heavy businesses for survival. This creates an economic interdependence, even if not a regulatory one.

Thefore “capital-light” label is accurate only when the agency business achieves scale and becomes self-sustaining. Going back to the root questions agency must ask:

• How scalable is the operating model to keep winning new mandates?
• How profitable is the fee income relative to operating costs?
• How much is the agency side contributing towards cross selling of products or services that augments principal-revenue?

And not just:

How low is your CIR?