Performance Measurement in Banking: Beyond ROE

INTRODUCTIONBanks are increasingly using return on equity as the ultimate performance scorecard. The adoption of risk-adjusted capital adequacy guidelines, successive years of poor profitability and the conceptual and practical failings of previously used measures, such as asset growth, have led management to focus on return on equity (ROE). They are measuring the ROEs' of each of the bank's component parts, such as sectors, lines of business and products. This shareholder value-oriented framework has spawned considerable changes not only in the way that performance is measured, but in the management processes used to plan, operate and control the bank (see Appendix). However, bank executives are finding that measuring risk-adjusted return on equity, while important, is not the entire story. Just as their counterparts in manufacturing and process industries discovered, the ROE report card provides a summary level picture of which parts of the bank are contributing to-or detracting from--shareholder value. It does not provide information as to the "how's" or "why's" of performance, much as a thermometer provides little in the way of diagnosis. Moreover, it does not indicate progress in terms of the bank's strategic agenda. While the product of sophisticated analytical, allocation and reporting mechanisms, it alone is inadequate.Therefore, adoption of a broader set of performance measurement indicators is required. The indicators are needed to provide a better sense of performance along strategic lines, as well as to show how drivers of value are affecting the institution. Other industries have led the charge. Our experience with banks suggests that they, too, are establishing institution-wide and line-of-business metrics that go beyond ROE to provide more insight into performance.THE PROBLEMAT1C MEASUREMENT FRAMEWORKAs astute observers of management have noted, if it's not measured, it's not delivered. But what should banks measure? Bank executives wrestle with this problem continually. Many end up blaming the management information systems for producing the wrong stuff. However, bank MIS produces either what is asked of it or, lacking guidance from policy makers, what is easiest to retrieve. Unfortunately, shooting the messenger (i.e., MIS) is simpler than taking the time and effort to define what is truly relevant information.In fairness, bank strategies and objectives evolve over time, which can cause "disconnects" between required measurements and extant systems. Also, banks have increasingly adopted line-of-business (LOB) organizational structures for management purposes which render their. previous legal-entity-focused reporting mechanisms obsolete. However, bank managers as a rule have not taken the time to fully define the measurement frameworks they are using for the bank and its component parts, and which need to be supported by MIS. The adoption of shareholder value and return on equity as key parts of the overall measurement frame- work has complicated matters.For example, Exhibit I (see page 16) shows several possible dimensions of bank measurement systems. (Exhibit I omitted) All are of value--though to different persons within the bank. Each combination of dimensions also has value. But it is unlikely that one single measurement system can support all of the combinations that are needed by the various organizations, levels and positions throughout the bank. Yet many banks do expect one system to provide all of the information needed to "steer the ship," and to focus on one set of indicators which reflect a true and comprehensive picture of performance.THE IMPLICATIONSEssentially, bank measurement systems are heavily weighted towards providing historical financial results. Whether at a bank-wide, line-of-business, legal entity or product level, performance is usually characterized in terms of income statement or balance sheet terms. Even advanced systems which can report risk-adjusted return on equity for multiple views of the bank merely (and we use the term advisedly) shift, splice and recalculate underlying financial data to produce their ROE results. …