Credit Risk Measurement

Managers of financial institutions like banks need to familiarize themselves with metrics and performance indicators for banking industry since these will help them in making profitable investment decisions.

To efficiently manage banks and financial institutions, identifying relevant metrics and performance indicators for the banking industry is very crucial.

Banks exist to provide consumers and businesses financial services. They are financial institutions that receive, transfer, pay, collect, exchange, lend, safeguard, and invest money in behalf of its customers or depositors. Services provided by banks are extremely important in free market economies, like United States and Canada. Two of their primary functions are to supply customers with mediums of exchange like checking accounts, credit cards, and cash; and to accept money from depositors and lending this to borrowers. These two functions allow an economy to expand and grow.

In the face of tight competition and changing customer loyalties, the use of key performance indicators (KPIs) and relevant metrics will certainly help bank managers and executives make good corporate decisions that will help them achieve their organizational objectives. KPIs are quantifiable measures that can give managers a quick assessment of performance. A common dilemma for managers is to identify which among the many metrics that can be easily obtained can be used as basis of organizational performance. The metrics that will be used as KPIs should be relevant and should yield information that will be extremely useful for managers who are running banks. As is discussed in many textbooks, these indicators should pass the SMART acronym criteria. They should be specific, measurable, achievable, relevant or result-oriented, and time-bound.

Key performance indicators may be financial or nonfinancial, and are usually based on the organizational structure and operating strategies of a bank. Liquidity ratios are often used and considered as crucial KPIs by many financial institutions. According to the Uniform Bank Performance Report, there are twelve liquidity ratios that banks can use as KPIs. The amount of uninvested funds is another KPI that will help bank managers determine the amount or percentage of bank funds that are fully invested and income-generating. Another indicator that will come handy for bank managers is the amount of loan commitments the bank has from the beginning to the end of a certain period. A table indicating these figures will illustrate activity. Moreover, to obtain profitability information, it is a good idea to monitor outstanding loans, new loans, ending total loans, and principal reduction. Other factors that can be treated as KPIs are ratio of active depositors against dormant depositors, number of depositors per branch, number of closed accounts, and number of issued credit cards monthly.

Aside from the metrics previously mentioned, rate of credit risk and default risk rate should also be given close attention. This is for the reason that credit risk is one of the major challenges that banks and lending institutions worldwide face. In fact, this is very crucial and may lead to bankruptcy, if left unattended. Efficient credit risk measurement tools should be used in order to maintain credit risk level well within an acceptable range. Despite the differences in management styles and organizational structures of banks, the metrics and performance indicators for banking industry previously mentioned should help bank managers accurately assess their performance.

Taking managerial decisions keeping growth, risk and returns in mind are tough and tricky for the best banking brains, but performance metrics can help…

Business decisions are getting tougher and tougher in a world of cut-throat competition and swaying customer loyalties. In a day and time when industry follows no fixed trend and age-old business practices are failing for no reason at all, making management decisions has become extremely tough. However the use of performance metrics and key performance indicators can actually help managers take better decisions and make calculated choices. As far as the banking sector is concerned, banking performance metrics may vary from performance metrics in other organizations. At the same time, different banks may choose to focus on different performance metrics based on their goals. Banking performance metrics about key focus areas in your company, based on the policies, vision and aims of your own organization can help you in analyzing current situations and determining future course of action in an extremely objective and calculated manner.

No matter what your goal is or what kind of banking policies you follow, the use of performance metrics in assessing the overall performance of your organization can definitely help you in improving the overall functioning of your bank and in pushing your profits. Since most banking sector decisions involve trade-offs between risk and returns, almost every bank is into calculating the newly evolved EVA (economic value added) and RAROC (risk-adjusted return on capital). On the other hand, due to the extreme importance that is being given to customer relations nowadays, formulae for performance metrics calculating customer satisfaction are being developed every other day.

In order to help the performance of their banks, most managers are nowadays using specialized software tools or calculators for determining their performance metrics. Other banks simply employ the services of consultancies and financial firms who assess performance in different areas and provide detailed metric values. In either case, banks today need to get data on key performance indicators in all sectors ranging from customer satisfaction, growth, employee turnover and performance, productivity, profitability and risk management. Some of the main performance metrics that almost all banks need to focus on are return on capital employed, overhead cost ratio, ,return on operating capital, return on average assets, operating margin, fee income level, non-interest income level and different types of capital ratios.

Many companies also use the balanced scorecard method for gathering and calculating their key performance metrics. The balanced scorecard is a tool that provides formulae for calculating different performance metrics for different organizations and different operational situations. Industry experts may use varying terms for denoting performance metrics like business activity monitoring, business intelligence, business performance management and enterprise metrics management but the plain and simple truth is that nobody is making any kind of decisions without first checking out their performance metrics.

Successful banking is impossible without continuously assessing performance variables and acting upon what these numbers tell you. Whether you run a small bank or a worldwide chain, you need to work with banking performance metrics before taking any decisions because performance metrics are the best decision making variables that you can get your hands on today.