In the previous two blogs related to the resurgence of profitability analysis in the banking industry (Defining the Challenge & Understanding the Process), we covered financial performance challenges facing financial institutions, the resurgence of profitability as a tool to help combat these challenges, and some considerations for implementing and/or improving profitability analysis processes. In this final blog, we will propose several best practices to consider as you work through the process.
- Consider all elements of profitability: As you develop your profitability framework, be sure to consider all components of the profitability picture, such as net interest margin, non-interest income and expense attribution (direct costs, allocated costs, unit costs, activity costs, etc.), loan loss provision and capital.
- Consider all dimensions of profitability: Look for opportunities to improve performance across a number of different segments within the institution. The ability to analyze, understand and ultimately act upon the profitability results within any segment will enable your institution to develop a comprehensive plan to not only improve financial results, but also improve operational performance. Our survey of more than 350 global chief financial officers and senior finance professionals, titled the 2017 CFO Outlook Survey: Performance Management Trends and Priorities for Financial Institutions, revealed these findings regarding the disconnect between institutional priorities and what actually gets measured.
- Establish a roadmap for your profitability analysis plans: Define what your end-vision looks like and then develop a roadmap to get there. It may start with creating a profitability framework for one segment and then building from there, or it might start with developing a matched-term FTP framework for net interest margin analysis followed with building components for cost attribution and capital allocations. This approach enables you to tackle each component individually without getting overwhelmed, and to build on your experience as you complete each phase. It also ensures that your institution remains focused on its overall priorities and goals throughout the process.
- The goal should not be perfect precision: Again, think about how you want to utilize the profitability results in your institution and ensure that your approaches and methodologies provide a consistent, defendable basis for those uses. In many cases, viewing profitability as a relative metric (comparing results against a baseline, against previous periods, and between segments) allows you to more effectively and efficiently agree upon the most appropriate methodologies.
- Create a profitability steering committee: Assemble a committee comprised of people from across the institution to help identify all of the uses of the information, develop a rollout and education plan, and review and vet methodologies, tools, results, etc.
- Make profitability matter: Consider the question we are often asked: “How do we get people to look at and understand the profitability results, let alone actually utilize them?” As we discussed previously, this often requires a cultural change for the organization, starting at the top. One critical element of that cultural change is making profitability matter. This can be achieved by tying the compensation of your department managers, line-of-business owners, branch managers, loan officers, etc., to actual profitability results. If their compensation is tied to the results, the results will matter to them.
Based on our survey results, it appears that many institutions will be undertaking actions in this area in the near future. Hopefully the information presented in this three-part series was helpful.