Bankers have never before been so dependent on timely, accurate performance measurement. The rapid pace of change in competitive conditions and the complexity of bank strategic imperatives call for ever more sophisticated information on rates of return, profitability, and the factors driving them.

The needs for better information upon which to make decisions and to track the results of decisions made, are constant themes in modern bank management.

To a large degree, banks' finance and information systems organizations have responded to the needs. Surveys, such as one recently sponsored by the Bank Administration Institute, and anecdotal evidence show that bank performance measurement systems are becoming ever more useful and sophisticated.

For example, at some banks profitability is being reported across multiple dimensions, including line of business, product, or customer, as opposed to traditional legal-entity-based reporting. Shareholder-value- based measures such as risk-adjusted return on capital and net income after capital charge are being used. And the use of other measures beyond traditional financial ones (sometimes termed the "balanced scorecard") is clearly on the rise.

Yet many of these measures, even the most sophisticated and newly adopted of them, are quite one-dimensional. They are time bound, reflecting previous periods. The "driving with the rear-view mirror" syndrome is writ large with such measures.

With so much of the business of banking being forward-looking, this exclusively retrospective bias is surprising. Loans are made with a sense of future repayment probabilities.

Demand deposit account balances wax and wane with economic activity and interest rates. Investments in new distribution channels are made with expectations of prospective sales and service patterns. Acquisitions are made to increase revenue streams and reduce cost structures.

How can traditional profitability and performance measurement be enhanced to provide more forward-looking value?

One way is fairly straightforward. It is to include leading indicators of future performance in historically oriented reporting systems.

For example, increases in delinquencies generally lead to more loan losses and chargeoffs. Reporting systems based on prior periods could be changed to do a better job of illustrating those relationships and pointing to future impacts.

Another valuable way is more difficult to accomplish. In essence, it means creating future-oriented performance perspectives which complement historical measures. Such future perspectives can be used to deepen managers' understanding of the potential effects of their decisions on future period results.

In fact, leading banks are already adopting future-oriented measurement and decision-support techniques. Three examples are described below.

Shareholder-value-based planning and reporting. Planning is essentially a forward-looking exercise. It requires managers to make educated guesses, or bets, on future events, actions, and impacts. The act of planning itself can provide insights, irrespective of the strategic or budgetary commitments that result.

Banks are increasingly concerned with their share-price performance. New planning and budgeting processes reflect the shareholder-value orientation. Business units project their financial results using consistent methodologies and assumptions. These results are discounted back to the present, with the impact of alternative strategies and scenarios expressed in shareholder value terms.

Reporting systems are being enhanced to show not just net income, but also contribution to shareholder value creation during the period. Measures such as NIACC (net income after capital charge), EVA (economic value added) and SVA (shareholder value added) are being used.

These measures can be related to the objectives developed during the forward looking planning/budgeting process to track progress in creating value.

Retail customer lifetime value. Customer relationship strategies have been put in place at many banks. Identifying target customers and developing actions to increase their profitability requires a forward looking, multiperiod measurement perspective.

Customer relationships develop and are maintained over time. Actions taken to acquire and retain customers, to sell additional products and services, and to change transaction behaviors have multiperiod consequences. Simply capturing the single-period effects - monthly, quarterly, or annual profit - provides a limited view of the real contribution of a relationship to shareholder value.

In response, some financial institutions are treating customer relationships as multiperiod assets, as opposed to single-period flows of revenue and expense. The value of the asset is the net present value of discount streams of net profit or loss generated by the customer over time. Customer asset value can be positively or negatively affected by the actions taken by the bank.

Credit card solicitation programs. A special instance of needing to know more than a single period's worth of profitability information is evaluation of credit card solicitation programs.

Credit card issuing companies that actively solicit new customers generally do so via targeted mailing or telemarketing campaigns. They need to know the results of those campaigns, not only in terms of the number of cards issued, but also how that specific campaign's portfolio behaves over time.

By carefully monitoring usage, balance, delinquency, chargeoffs, and attrition rates of program cohorts over time, card issuers gain insights into the profitability dynamics of various customer types. They can then target marketing efforts more effectively. They can also better compare acquisition expenditures with likely payoffs.


Classic single period profitability reporting is valuable to bank managers in providing an understanding of earnings and progress against budgeted objectives. Yet it is incomplete.

More advanced techniques embody forward-looking, multiperiod perspectives. They complement traditional profit measures. They are more useful in understanding long-term shareholder value creation and the factors driving it. Mr. Karr is partner at Ernst & Young LLP, the New York accounting firm.

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