Financial Services

January 2012
After the fnancial crisis that began in 2008, banks are taking steps to improve their performance
measurement capabilities in light of changed economic and market conditions and new
management needs. For example, new regulatory strictures are affecting the underlying
economics of such businesses as payment-card issuing and processing. Capital requirements are
increasing for most banking businesses. New channels like mobile phones are becoming more
important. Revenue growth continues to be diffcult to achieve due to weak economic conditions,
low interest rates and regulatory restrictions. Banks are trying to manage costs better, deepen
relations with customers and enhance product mix and pricing decisions. These and other factors
are causing banks to re-examine and improve the ways in which they measure and report business
performance.
Some major areas of emphasis and trends are emerging across the industry:
Reviewing and enhancing organizational management proftability-reporting methodologies
Emphasizing the use of business-unit key performance indicators (KPIs)
Refning customer- and channel-proftability measurement and analytics
Improving alignment of the components of the performance management process
Improving systems support and automation of the performance management process
Improving data quality and consistency
Banks have their own performance measurement improvement agendas tied to their unique
needs and strategies. For some banks, these are continuations of prior efforts while for
others, they are new initiatives.
Banks are reviewing and enhancing key organizational management
proftability-reporting methodologies to refect changes in business models
and their underlying economics. One focus is harmonization with risk
management methods and defnitions
Cost allocation. Allocation methodologies are being changed to provide more transparency
to recipients and to support better decisions about the use of resources. More attention is
being paid to understanding fxed and variable cost structures and cost and volume variances.
Deeper analyses of channel costs are being developed. For certain categories of costs, such as
overhead or administrative functions, allocations are being simplifed to streamline budgeting
and proftability-reporting processes.
Performance measurement in the
banking industry post-crisis trends
by John Karr
2 Performance measurement in the banking industry post-crisis trends
Funds transfer pricing. FTP curves are being changed. The use of
the swaps curve as opposed to LIBOR for maturities between three
months and one year is becoming more common. Liquidity premiums
are being added to refect the banks specifc funding costs at each
point in the curve. More analysis is being performed on the core
deposit book to determine its stickiness.
Credit charges. Approaches to assigning provision for credit losses
are being modifed. The use of Basel-driven expected losses versus
GAAP provision is being considered. Further, the implications of
mark-to-market loan valuation under accounting pronouncements
such as SOP 03-3 and FAS 141-R on monthly line-of-business results
are being analyzed.
Capital allocation. Banks that attribute equity to lines of business for
organizational-proftability reporting are revising their methodologies
for doing so. Because regulatory capital requirements are being
raised, banks are not using economic capital calculations as the
sole bases for line-of-business (LOB) capital attribution. Instead,
combinations of economic capital, regulatory capital and goodwill
attributions are being used. Despite the new capital attribution
methodologies, considerable shareholder equity continues to be held
at the top of the house.
Inter-LOB revenue and expense-sharing arrangements. Banks
are reviewing the methods by which revenues and expenses are
shared among LOBs. They want to promote cross-selling, as well as to
understand the true stand-alone economic value of each business line.
In some cases, fat amounts or percentages of revenue are being put
in place for cross-sales or referrals between LOBs.
Banks are emphasizing the use of line-of-business
key performance indicators to supplement monthly
organizational proftability reporting
At most large US banks, monthly organizational proftability reporting is
sophisticated and well-accepted. However, bank executives are looking
for measures that will assist them in understanding potential future
performance, as well as in analyzing historical fnancial performance.
The use of enterprise and LOB-specifc KPIs in management reporting
is growing. Banks are determining which KPIs will allow them to gain
insights into the underlying performance of the business beyond a
purely fnancial view. Reporting on KPIs that truly drive value provides
more information upon which to make decisions and engage in
strategic discussions about the business.
Determining the KPIs that will be used requires developing a model of
the business and analyzing the levers that have the greatest impact
on its performance. It also calls for defning the levels in the LOB
hierarchy at which the KPIs will be reported.
Each bank has its own ideas about which KPIs are appropriate to LOBs
based on its strategy and views of the business. For the most part, KPIs
currently in use are fairly simple and intuitive. However, as driver-based
models become more precise and complex, LOB KPIs are likely to
evolve as well. Some typical KPIs used for retail banking LOBs include
new accounts opened; account attrition; balance growth; products
per household or customer; delinquencies; net promoter score; and
headcount. KPIs can be developed for subsets of the retail LOB,
including product lines such as mortgages, credit cards and insurance
Banks are refning customer- and channel-proftability
reporting and analytics to support new strategies
Most banks have adopted customer-centric strategies. These strategies
involve customer segmentation, needs and behavior analysis, product
features, sales and service process design and pricing strategies, among
other attributes. To develop and implement customer-centric strategies,
banks need a deep understanding of customer proftability and economics
on annual- and lifetime-value bases.
As a result, banks are enhancing their customer-proftability
calculation and analysis capabilities. Capturing accurate and
comprehensive data on customers overall relationships with the
bank in terms of accounts, products and sales and service interaction
has been a major focus, as has refning proftability-calculation
methodologies. Understanding which customers or groups of
customers are proftable or unproftable and why provides banks with
information upon which to make marketing and pricing decisions.
More channels, such as online and mobile ones, are being added to
traditional channels like branches and call centers. Investments in them
must be optimized. Consequently, banks are improving their analyses of
channel economics, which involves developing models of channel costs,
usage patterns and impacts on sales and customer retention.
Even traditional metrics, such as branch proftability, are being
challenged. Most banks measure monthly branch proftability using
a common framework. Essentially, they create an income statement
for the branch, which includes revenues (based on spreads and fees),
credit costs, operating costs and allocated expenses. The asset and
liability balances attributed to the branch are based on the accounts
booked to it when a customer originates the account. Fees are also
largely based on activities related to customer accounts booked to a
branch although some branch P&Ls also include other line items, such
as usage fees for ATMs located in the branch.
Under this traditional proftability construct, it can take years for
branches to be deemed proftable. That is, customer numbers and
associated balances attributed to the branch need to accumulate
over time before spread and fee revenues exceed direct and allocated
costs. Bankers undergo an anguished waiting game hoping that their
branch placement bets will pay off.
Such a manner of measuring branch proftability is clearly
inadequate, and certainly not one that any modern retailer would
use. It credits the branch at which the customer frst originated his
or her account with the balances of the account, even if the customer
has never again set foot in that branch. It offers no incentive for the
provision of high-quality service in the time period it is most needed
3
(when the branch is being opened) because direct compensation
expense is charged to the P&L while balances are low. It muddies the
contribution of other sales and service channels to overall customer
satisfaction and proftability. Finally, it can delay decision-making
about whether the branch is truly contributing value to the bank.
To counter this, a more accurate picture of branch-level proft
performance needs to be constructed. Such a picture should be
more sensitive to actual performance during the reporting period
as opposed to prior periods. It should refect the effectiveness of
the branch as a sales and service channel. Finally, it should be more
sensitive to the operational levers that management can push or pull
to infuence the performance of the branch.
One approach would be to change the items driving the monthly
branch P&L. Rather than holding assets and liabilities accreted over
time on its own balance sheet, the branch would be credited only
for loans or deposits generated during the month. The bank would
purchase the deposits or loans from the branch at their economic
net present value. (One analogy is the mortgage-banking business, in
which loan production offces sell the loans downstream rather than
holding them on their own books.) The branch would also be credited
for the customer service transactions it performs during the month.
Monthly operating expenses, direct and allocated, would be deducted
to arrive at a true monthly P&L amount. This would provide managers
with a better understanding of branch performance.
Because of the increased importance of forward-looking
activities such as forecasting and stress testing, banks
are better aligning the components of the performance
management process
Banks are taking steps to see that the key components of the
performance management process involve consistent defnitions,
hierarchies and methodologies. A schematic representation of the
major components of the performance management process is shown
in Figure 1. For example, forecasts are being presented using the same
line-of-business and P&L constructs as for monthly reporting. Stress
testing is becoming a repeatable process performed in parallel with
forecasting. Also, consistent capital attribution methodologies are
being used for strategic planning, capital budgeting, reporting and
forecasting. Driver-based planning is now widely used, and the drivers
are employed in forecasting as well.
As previously noted, banks are also harmonizing fnancial views of the
business and associated reporting with risk views and reports. This
involves standardizing defnitions (e.g., product types) and hierarchies
and roll-up structures. Where regulatory methods and reporting, such
as for Basel III, vary from GAAP accounting principles for balance sheet
and income statement items (e.g., for credit exposures), institutions are
attempting to explicitly reconcile and explain the differences.
Improving systems support and automation of the
performance management process are critical elements
in most banks plans
Banks are undertaking a variety of systems initiatives to streamline
and automate components of their performance management
process. These include implementing new fnancial planning and
budgeting systems, developing new forecasting and stress testing
systems and further automating standard monthly reporting
processes such as cost allocation. Some banks are improving
enterprise, LOB and functional reporting and analytic capabilities
through the use of dashboards and data visualization software.
The rationales for such performance management systems and
automation investments vary and can include the following:
Reducing operational costs. Automation can reduce or eliminate
such manual activities as data entry, re-keying, reconciliation and so
forth. Also, if there are multiple systems supporting the same process
(e.g., budgeting) across the enterprise, moving to a single system can
reduce licensing costs.
Strategic
planning
Budgeting/
capital planning
Reporting/
analytics
Forecasting Monitoring Acting
Feedback
Figure 1: Illustrative performance management process
Risk management Internal/external communications Compensation, incentives and rewards
Integrated technology Change management
Related processes
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Reducing production-cycle times. Automating certain processes can speed up information
reporting and provision. Financial planning and budget automation can reduce the number of
iterations required and the time between iterations.
Improving controls. Many banks performance management processes are still heavily
dependent on spreadsheets and local databases. Besides the costs associated with manual
intervention, this can also create control weaknesses. Information reporting quality can suffer.
Vendor support. In some cases, vendors have stopped supporting certain application
software packages or older versions of such applications. This requires banks to select and
implement replacements.
Banks are investing heavily in improving data availability, quality and
consistency, and performance management data is no exception
During the crisis, banks struggled to pull together complete and accurate reports of their
positions, exposures and counterparties. Performing stress tests was an onerous exercise
due to data gaps and inconsistencies. Regulators, boards and management all concluded
that signifcant improvements in data quality were necessary to run banks effectively in the
post-crisis era. As a result, virtually every large US bank is undertaking efforts to improve data
quality across the enterprise.
Data used in performance management processes is no exception. In fact, it is a focal point.
The key data improvement activities in the banking industry that will enhance performance
management and reporting include:
Data governance. Banks are putting in place improved data governance approaches. Among
these are specifying organizational responsibilities and processes for data defnitions,
ownership, validation and change control.
Data sourcing. Multiple data sources are being rationalized. Golden sources are being
defned for specifc data sets and uses. Enterprise data warehouses are being built and
implemented to serve multiple purposes, including performance measurement and reporting.
The creation of data marts for unique users and user groups is still taking place, but under
much more disciplined and rigorous governance.
Data quality. In parallel with the actions described above, signifcant efforts are underway
to improve data quality. This involves cleansing data in source systems and making sure that
required data attributes are complete and accurate. Data quality maintenance processes are
being enhanced so that data does not go stale or become corrupted over time.
Conclusion
Of course, individual banks face their own performance measurement circumstances and
needs, such as integrating acquisitions into existing proftability measurement, budgeting and
forecasting systems and tools. However, large US banks will eventually take steps to address
the performance management issues described above. Bank fnance, information technology,
treasury, risk, operations and business unit managers will need to work together to improve
performance management processes and systems at their institutions.

John Karr is a Principal in the Financial Services Offce of Ernst & Young LLP.
He is based in New York.