Figuring Out Where the Profits Come From

Seeking control over risk-reward payoffs, bankers are working furiously to get a better handle on which businesses and products are profitable.

"All of a sudden, bankers don't have a choice," said John Dorman, president of Treasury Services Corp., a Santa Monica, Calif., consulting firm that specializes in profitability analysis. "With the shakeout of winners and losers, it's clear the winners know where they make money."

A Widespread Change

Virtually all big banks are working to improve the accounting techniques, performance standards, and computer systems used to generate profitability reports. Observers cite three banking companies as working hardest on the problem: Bank of New York Co., First Fidelity Bancorp., and First American Bancshares.

"The whole industry is changing how it looks at profitability," said Steven G. Bruggers, vice president at Bank of New York. "When we first started doing profitability analyses, the question was: How do you assign costs?" Mr. Bruggers said. "Now we are more concerned with the contribution to the business of each product line."

The chief reason behind this push is bankers' concern that revenue growth will be slow in the near future. That leaves them one way to improve capital: Squeeze more profit out of the money that comes in.

Being able to determine the revenues and costs of specific products, customers, and business lines is the first step.

In the Lead

Almost all major banks already can measure the profitability of main lines of business. But some of the best-run banks, most notably Bankers Trust New York Corp. and Banc One Corp., have sophisticated ways to report on business unit and product profitability.

At Bankers Trust, for example, every loan decision is weighed on a system that measures the risk-adjusted return on capital. And Banc One is able to measure the performance of its 50 affiliate banks and track which ones are not producing.

Room for Improvement

These two companies, however, are exceptions to the rule.

Accounting methods can be subject to numerous interpretations, and data covering sales, loans, or deposit activity may sometimes be inconsistent.

At most banks, senior executives are putting less confidence in profitability reports that rely on such methods or data.

Even banks that have been working on profitability reports for a decade find room for improvement.

These reports are not merely academic. Some banks have used them as the basis for deciding which businesses to stay in and which to leave.

Bailing Out

Bank of New York, for example, which has had some type of profitability analysis for a decade, gave up its primary dealership in government securities, a retail lockbox operation, and a mutual fund accounting business based on the information gathered for such analyses.

To make profitability reports more credible to executives and more useful in today's tough environment, banks are working to improve accounting methods and computer systems.

And they are moving to measure profitability not just in terms of dollars earned but also on more rigid tests, such as return on equity.

Accounting methods underpin this more rigorous approach.

Matched-Rate Funding

After years a "ballparking" costs and earnings, banks are now working on a more precise method. The goal is to establish the actual cost to the bank of an asset or liability.

This bookkeeping discipline is called matched-rate funding. It requires a bank to spell out, for example, exactly which funds cover which liabilities. The techniques is not new, but it is new to banking.

In the vast majority of banks, cost accounting never gets more complex than figuring out the general costs and allocating them as overheard to business.

Cross-Subsidies Decried

In such banks, the true cost of assets and liabilities are ignored. An the profitability systems built around that accounting are of limited use in a tougher economy.

"Banks are built on cross-subsidies between business lines," said Mr. Dorman of Treasury Services Corp. "That's no longer viable."

On the technology side, banks are working to increase the timeliness of profitability information by adopting techniques to gain access to key sales, deposit, and loan information in the computer system. 50 affiliate banks and track which ones are not producing.

Room for Improvement

These two companies, however, are exceptions to the rule.

Accounting methods can be subject to numerous interpretations, and data covering sales, loans, or deposit activity may sometimes be inconsistent.

At most banks, senior executives are putting less confidence in profitability reports that rely on such methods or data.

Even banks that have been working on profitability reports for a decade find room for improvement.

These reports are not merely academic. Some banks have used them as the basis for deciding which businesses to stay in and which to leave.

Bailing Out

Bank of New York, for example, which has had some type of profitability analysis for a decade, gave up its primary dealership in government securities, a retail lockbox operation, and a mutual fund accounting business based on the information gathered for such analyses.

To make profitability reports more credible to executives and more useful in today's tough environment, banks are working to improve accounting methods and computer systems.

And they are moving to measure profitability not just in terms of dollars earned but also on more rigid tests, such as return on equity.

Accounting methods under-pin this more rigorous approach.

Matched-Rate Funding

After years of "ballparking" costs and earnings, banks are now working on a more precise method. The goal is to establish the actual cost to the bank of an asset or liability.

This bookkeeping discipline is called matched-rate funding. It requires a bank to spell out, for example, exactly which funds cover which liabilities. The technique is not new, but it is new to banking.

In the vast majority of banks, cost accounting never gets more complex than figuring out the general costs and allocating them as overhead to businesses.

Cross-Subsidies Decried

In such banks, the true cost of assets and liabilities are ignored. And the profitability systems built around that accounting are of limited use in a tougher economy.

"Banks are built on cross-subsidies between business lines," said Mr. Dorman of Treasury Services Corp. "That's no longer viable."

On the technology side, banks are working to increase the time-liness of profitability information by adopting techniques to gain access to key sales, deposit, and loan information in the computer systems.

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