bank directors scorecard
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PERFORMANCEEVALUATING BANK
A Course for Bank Directors
October 5, 2004 3:30p.m. 4:45p.m.
2004 ABA Annual ConventionOctober 3-6, 2004
Marriott Marquis New York, NY
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E V A L U A T I N G B A N K P E R F O R M A N C E
A Course for Bank Directors
Agenda
The Role of the Bank Director Risks and Returns of Banking
Bank Performance Metrics
Evaluating Overall Bank Performance: Risk-Adjusted Measures
Other Performance Measurement Tools for the Bank Director
Historical Perspectives
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E V A L U A T I N G B A N K P E R F O R M A N C E
A Course for Bank Directors
The Role of the Bank Director:Risk Governance
Banking is entirely a risk business
Positions = Financial Risk
Fee-Based Businesses = Reputation / Compliance Risk that cannot be
hedged and for which there is no materiality threshold
Bank Directors must approve business strategies with a key
focus on risk appetite
This, in turn, requires risk-adjusted performance measures
It also requires that risk be viewed from a qualitative as well asquantitative perspective
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E V A L U A T I N G B A N K P E R F O R M A N C E
A Course for Bank Directors
The Role of the Bank Director:Risk Governance Framework
The People and their Roles:
Board of Directors
Approve strategies and risk appetite, monitor performance, exercise constructivecriticism
Senior Management
Develop strategies and execute day-to-day, be transparent and candid withBoard, encourage inquiry
Other Issues to Consider:
Appropriate policies, procedures and limits, including new product/businessprocesses
Effective infrastructure for measuring and monitoring performance
Comprehensive internal controls and audit
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E V A L U A T I N G B A N K P E R F O R M A N C E
A Course for Bank Directors
The Role of the Bank Director:Assessing Financial Performance
Peer Group and Other Comparative Information
Uniform Bank Performance Report (UBPR)
Bank Holding Company Performance Report (BHCPR)
Profit and Loss = Risk Roadmap
But only if profit gets equal or greater focus than losses
Is high growth/profit based on well-understood, true competitive
advantage?
Lots of data but little information?
Are data viewed with a false sense of precision and
comprehensiveness?
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E V A L U A T I N G B A N K P E R F O R M A N C E
A Course for Bank Directors
The Role of the Bank Director:Assessing Non-Financial Performance
Are there any patterns or themes of control weakness / non-
compliance?
Oversight of new businesses and products
Is requisite infrastructure in place?
Has pre-launch due diligence been thorough?
Is management dismissive of regulators or regulatory issues?
Are risks owned by line managers and overseen by independentrisk managers (including compliance and audit) with requisite
authority and competence?
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E V A L U A T I N G B A N K P E R F O R M A N C E
A Course for Bank Directors
Questions that were never asked
How can a significant portion of our trading revenue be generated by
someone engaged in arbitrage in a remote location?
How has our business made great returns every year for the last X,including during periods of significant market stress and turmoil?
Is this product truly the result of just tweaking an existing product? Or havewe actually put a jet engine on a tricycle we are planning to sell to a five-year old?
Is a limit that is never breached effective?
E V A L U A T I N G B A N K P E R F O R M A N C E
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E V A L U A T I N G B A N K P E R F O R M A N C E
A Course for Bank Directors
Bank Performance Metrics:Risk & Returns
Channel / Market Wholesale / Retail Branch / Internet
Institutional /
Individual
Legal Structure Holding Company Bank
Broker / Dealer
Investment Manager
Business Lines Commercial Banking Retail Banking
Sales & Trading
Corp Finance / M&A
Asset Management Private Banking
Security Services
Risks Market Credit Operational
Liquidity Reputational Business
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E V A L U A T I N G B A N K P E R F O R M A N C E
A Course for Bank Directors
Bank Performance Metrics:Commercial Banking
Financial Metrics
Earnings/Profitability Net Interest Margin, Return on
Assets, Loan Growth, Fee Income,Operating Efficiency
Asset Quality Write-offs, Loan Loss Reserves,
Non-Performing Ratio,Concentrations (Industry, Obligor,Country, Rating)
Capital Leverage Ratio, Regulatory
Capital
Interest Rate Sensitivity
Non-Financial Metrics Market Share Agent
Portfolio
Risks Market Credit Operational Reputational
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E V A L U A T I N G B A N K P E R F O R M A N C E
A Course for Bank Directors
Bank Performance Metrics:Retail Banking
Financial Metrics Earnings / Profitability
Net Interest Margin, Return onAssets, Loan Growth, Fee Income,Operating Efficiency Ratio
Asset Quality FICO bands, Loss Rates, Loan
Loss Reserves, Liquidity Ratio,Non-Performing Ratio,Concentrations
Capital Leverage Ratio, Regulatory Capital
Interest Rate Sensitivity
Non-Financial Metrics Market Share
Reputation
Compliance Controls
Branch Network
Core Deposits
Risks Market Credit Operational Reputational
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E V A L U A T I N G B A N K P E R F O R M A N C E
A Course for Bank Directors
Bank Performance Metrics:Sales and Trading
Financial Metrics Trading Income
Customer vs. Proprietary P&L
Daily Volatility / Information Ratio
Value-at-Risk
Stress Testing
Non-Financial Metrics Market Share of Over-the-Counter
(OTC) and Exchange Markets
League Table Standings
Sales and Coverage
Risks Market Credit Operational
E V A L U A T I N G B A N K P E R F O R M A N C E
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E V A L U A T I N G B A N K P E R F O R M A N C E
A Course for Bank Directors
Bank Performance Metrics:Corporate Finance / M&A
Financial Metrics Fee Income
Principal Investments Income
Expenses (Fixed vs. Variable)
Non-Financial Metrics IPOs / Deals
League Tables
Volume of Securities Underwritten
% Acting as Lead Manager in
Syndicate
Specialization
Risks Reputational Business Operational
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E V A L U A T I N G B A N K P E R F O R M A N C E
A Course for Bank Directors
Bank Performance Metrics:Asset Management
Financial Metrics Fee Income by Product Type
Asset-Under-Management
Profit Margin
Cost Ratio / Efficiency Ratio
Average Asset Size
Non-Financial Metrics Broker / Sales Force
Level of Cross-Selling
Number of Products Offered
Risks Business Reputational
E V A L U A T I N G B A N K P E R F O R M A N C E
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E V A L U A T I N G B A N K P E R F O R M A N C E
A Course for Bank Directors
Evaluating Overall Bank Performance:Risk-Adjusted Measures
Measuring a banks performance across the enterprise:
Risk-Adjusted Return on Capital (RAROC) and Economic Profit (EP)
Shareholder Value Added (SVA)
Economic
Profit
Economic Capital Hurdle Rate
RAROC
x- [
Return Economic Capital
Return
]
SVA - [ ]xet Operating ProfitAfter Tax Cost of Capitalapital
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E V A L U A T I N G B A N K P E R F O R M A N C E
A Course for Bank Directors
Evaluating Overall Bank Performance:Risk-Adjusted Measures
Risk-Adjusted Return on Capital (RAROC) and Economic Profit (EP)
It is a profitability ratio that can be calculated for the entire portfolio, or byproduct or business line
Because it is risk-adjusted, it can be used to compare different types ofbusinesses (trading book vs. banking book, asset vs. liability products)
It can be used to evaluate existing performance, and also to boostperformance through the proper allocation of capital among product orbusiness line
In some ways, it is a short-run perspective (business unit profit is compared tothe units current capital at risk)
According to a 2002 survey sponsored by ISDA and the RMA, 78% of thebanks surveyed used RAROC.
Regulatory drivers include SR 99-18 and Basel II, Pillar 2
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E V A L U A T I N G B A N K P E R F O R M A N C E
A Course for Bank Directors
Evaluating Overall Bank Performance:Risk-Adjusted Measures
Shareholder Value Added (SVA) is a: Measure of economic profit, or the amount by which earnings exceed or fall
short of the required minimum rate of return that shareholders could get by
investing in other securities of comparable risk (often multi-period).
Long-run perspective in some ways, since business unit profit is compared tothe cost of capital of the bank.
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A Course for Bank Directors
Evaluating Overall Bank Performance:Applications of Risk-Adjusted Measures
Annual Budgeting and Reporting of Actuals
Projections and monitoring of performance and capital requirements
Economic capital adequacy and usage
Strategic Planning
Scenario evaluation of business segments, acquisitions and divestitures
Evaluation of optimal capital and balance sheet structure
Allocation of capital resources among internal units
Risk-Based Pricing Evaluation of transaction pricing on a risk/return basis for businesses,
however in conjunction with other considerations (e.g. relationship
value)
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A Course for Bank Directors
Evaluating Overall Bank Performance:Applications of Risk-Adjusted Measures
Risk Management
Alignment of risk limits with risk/return tolerances through capital based
limit frameworks
Incentive Compensation
Encourages behavior and culture consistent with organizations financialobjectives to manage return relative to risk
Addresses complications with GAAP reporting measures, which can
distort actual economic performance
External Disclosure Communication of metrics that show a truer economic picture
Demonstrates rigor around value-driven financial management to
clearly-defined objectives
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A Course for Bank Directors
Evaluating Overall Bank Performance:Risk-Adjusted Measures and Relationship Pricing
Risk-Adjusted Measures are being increasingly used in capturing
Relationship Pricing / Customer Profitability
Focus on capturing maximum share of customer wallet
Offers a method of capturing very different businesses under a common,
risk-based method
Example: Commercial Lending and Corporate Finance / M&A
Used to price new business, identify high / low value existing business
Multi-period relationships can be managed on a new and old business
basis
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A Course for Bank Directors
Other Performance Measurement Tools:Balanced Scorecard
The Balanced Scorecard:
Is a framework for translating strategic objectives into a set of performanceindicators (financial, customer, internal business processes, and learningand growth)
Argues that return-on-investment, market share, and earnings-per-share donot provide the full perspective of an organizations performance
Must balance internal and process measures with results and financialmeasures (i.e. balanced scorecard)
Also balances short-term and long-term goals
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A Course for Bank Directors
Other Performance Measurement Tools:Balanced Scorecard
Sample objectives of a balanced scorecard:
Loan volume growth
Customer retention
Percentage return on equity (ROE)
Number of hours spent with customers
Level of credit authority
Cross-selling to customer base
Internal Audit and Compliance scores
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A Course for Bank Directors
Other Performance Measurement Tools:Uniform Bank Performance Report (UBPR)
The UBPR:
Is an analytical tool created for bank supervisory, examination, andmanagement purposes
Comes from the Federal Financial Institutions Examination Council (FFIEC),
an inter-agency body for the Federal Reserve (FRB), Federal DepositInsurance Corporation (FDIC), Office of the Comptroller of the Currency(OCC), among others
Provides performance and balance sheet composition data
Helps evaluate adequacy of earnings, liquidity, capital, asset and liabilitymanagement, and growth management
Is produced quarterly using bank call reports
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A Course for Bank Directors
Other Performance Measurement Tools:Uniform Bank Performance Report
The UBPR can be used to:
Evaluate the banks current condition and trends in its financial performance
Compare the banks performance to its peer group
For instance, the UBPR allows uniform comparison of commercial banks:
A UBPR is produced for each commercial bank in the U.S. that issupervised by the Board of Governors of FRB, FDIC, or OCC
UBPRs are also produced for FDIC insured savings banks
Provides statistics of peer groups (Peer Group Report and percentilerankings)
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A Course for Bank Directors
Other Performance Measurement Tools:Uniform Bank Performance Report
Limitations of the UBPR include:
UBPR definition of peers?
The Peer Group Report is a relative measure
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A Course for Bank Directors
Contacts
Donald Vangel (212) 773-2129Office of the Chairman donald.vangel@ey.com
Advisor, Regulatory Compliance
Hank Prybylski (212) 773-2823Practice Leader lawrence.prybylski@ey.com
Financial Services AdvisoryRisk Management
Samir Nangea (212) 773-6742Senior Manager samir.nangea@ey.com
Financial Services AdvisoryRisk Management
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