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.