Does planning make a bank more effective?

Bexley, James B. ; Ashorn, Leroy W. ; Quarles, N. Ross 等

INTRODUCTION

A properly orchestrated plan will begin with a planning session, usually led by an outside facilitator that puts into focus the general direction the bank should take over the next three to five years. Make sure the facilitator understands banking in practice not just theory. The planning meeting or retreat should involve senior management and members of the board of directors, and must be held away from the bank-preferably an hour or more away to avoid distractions! Management should deal with directors' concerns, strengths of the bank, weaknesses of the bank, opportunities available to the bank, and threats to the bank, as well as specific issues such as the economy, existing markets and potential new markets, competition, new and existing products products, technology, staffing and budgets. After the issues of strengths, weaknesses, opportunities, and threats are addressed, the bank must deal with the financial drivers that can make or break profitability, and must be mindful of what the competition is doing.

PLANNING IS NOT A ONE-TIME THING

There has been a tendency on the part of some banks to not perform the planning process on an annual basis, however when a major anomaly occurs such as a drop in earnings or loss in market share, banks then determine that there must be a need for a major planning session. Banks should conduct a planning meeting annually. Markets that banks serve change over time and banks must change to meet the needs of their customers and take what the market will give them. Therefore, it is important for banks to conduct annual planning sessions to stay abreast of the needs of the customers and prospects in that market as well as to evaluate what the competition has to offer.

PLANNING IMPACTS PROFITABILITY

After addressing the more global aspects of the planning process, the key to "fine-tuning" the bank's profitability revolves around the following specific issues:

Fine Tune Earnings

Effective Deposit and Loan Pricing

Delivery of Quality Service

Expense Control

Incentives

Increase Net Interest Margin

Strengthen Asset Quality

Effective Marketing

Fee Income Generation

Positive Perception of Bank.

Fine Tune Earnings

Sometimes, a little fine-tuning is all that it takes to enhance earnings. Some methods banks could use include examining what peer banks are doing, evaluate what high performance banks are doing, and last, look for expenses that can be eliminated or reduced. In today's highly competitive environment, the difference between successful banks and mediocre banks may be brought about by very small adjustments. In the year 2000, the average community bank had a return on assets of 1.37 percent. In the following chart, peer banks in a given area are measured and charted for their return on average assets, which is an excellent device to instantly measure the subject bank to its peers.

[GRAPHIC OMITTED]

In the foregoing chart, the state and county names have been taken out of the charts and the "subject bank" is indicated by a heavy, dashed line. It should be noted that the subject bank in this example is performing well above the national average.

Increase Net Interest Margin

When banks had over fifty percent of their deposits free of interest costs as recently as the early to mid-1970s, it was not uncommon for the average bank to have a net interest margin of six or seven percent. In today's environment, a four percent net interest margin is considered extremely good. Since banking by simple definition is buying money at one price and selling it at a price, it becomes obvious that net interest margin is, perhaps, the most important factor impacting profitability. Pricing in the areas of deposits and loans have the most significant impact on the net interest margin and are discussed below. The following chart shows the subject bank is performing over the four percent level and half of its competitors are performing above the four percent level. This chart tells the bank that it must continue to watch its margins to stay competitive in their market.

[GRAPHIC OMITTED]

Effective Deposit and Loan Pricing

As noted in the above discussion, net interest margins are shrinking and present the greatest threat to bank profitability. Competition has caused some banks to pay more for deposits than they should. Likewise, some banks allow competition to drive down the rate that they charge for loans. Since loans constitute approximately two-thirds of the average community bank, and deposits constitute roughly ninety percent of the funding source for loans, a bank can severely impact its profitability by failing to carefully establish pricing policies for both loans and deposits. Note in chart 3 that the subject bank has priced its deposits in the lower quadrant of its market and in chart 4 that the loans are priced in the upper quadrant of the market.

[GRAPHIC OMITTED]

[GRAPHIC OMITTED]

There is a tendency for competition to cause banks to pay more for deposits to attract more deposits and avoid losing existing deposits. While this strategy is certainly flawed, it is prevalent in the industry. Likewise, competition or weak loan demand causes some banks to lower their loan rates to attract more loans as well as keep the existing loans. Planning and establishing strategies is vital to the pricing process.

Strengthen Asset Quality

A community banker once noted that asset quality at ninety-nine percent equates to a one percent loss! If the average community bank has one percent of its loan portfolio charged off, it would effectively reduce its return on assets by approximately one-half. For example, a $100 million bank earning a return on average assets of 1.2% would earn $1.2 million annually. However, if there is a 1% loss caused by loan losses, it would reduce its earnings by over one-half! To insure adequate quality, a bank should have a credit analysis program, which would carefully analyze statements of prospective loan customers before approving loans. To avoid asset quality deterioration, the bank should develop a formal credit review process, to provide quality control in the area of loan quality, loan documentation and credit/collateral exceptions. Additionally, the bank should address asset quality problems immediately.

Delivery of Quality Service

Business Week reported in its October 23, 2000 issue that bank customers perceive an 8.1% reduction in quality service delivery in the past six years. It was noted that service was more important than price. Further the article stated that service quality starts with management. An additional tool is asking customers and prospects in focus groups to evaluate service quality. Employing "shoppers" to evaluate service is also an effective tool. A major problem in society today exists because firms do not know what their customers want-even though most companies think they know what their customers want.

A bank must not implement a program and assume it will meet the needs of the customer and forget it. Instead, the bank must constantly be fine-tuning its service delivery to insure that the bank is satisfying the customer and doing it in such a fashion that it meets or exceeds what our competition is able to do. Products, customers, competition, and employees all change and your methods must change to meet the ever-changing marketplace. Berry (1999) found that there were three challenges in sustaining service quality success. He said the three challenges are operating effectively while growing rapidly, operating effectively when competing on price, and maintaining the initial entrepreneurial spirit of the younger, smaller company.

Effective Marketing

To be effective in the marketing arena, community banks must know the competition, know their own bank, know the customers and prospects, understand the make-up of their market, and last, adjust the marketing approach to what the marketing will give the bank. The bank must have a grasp of its present penetration of the marketplace, and at the same time, it is equally important to know its competitors' share of the market. Without such information, it would be extremely difficult to make an accurate assessment of the bank's prior year successes or failures in the marketplace, and more importantly, address where the bank is going. The level of market penetration is a valuable device as a planning tool. It can provide strong and weak segments of the market for the bank, as well as providing the same data about its principal competitors.

Market penetration gain or loss provides one of the best early warning devices to management, signaling potential strengths or weaknesses for the bank or its competitors. To make a proper assessment of market penetration, it is necessary to look at the overall picture for the past several years, not just one year. Additionally, it is important to look at the combined effects of present market penetration by the bank and its competitors and look at the bank's greatest potential for growth.

Expense Control

Expense control is a process-not an edict. Additionally, controlling expenses is important to the bottom-line when the bank focuses on the fact that salary expenses normally constitute the largest non-interest expense in the bank. Therefore, it is important that everyone in the organization be involved in as well as "buy-in" expense control. A good rule of thumb would be to have no more that four-tenths of one employee per million dollars of assets in banks with six or fewer branches. As noted in the following table, the subject bank is below the four-tenths of one employee per million dollars in assets.

[GRAPHIC OMITTED]

Fee Income Generation

Fee income is the most logical means of relieving pressure on net interest margins. However, conventional fee income generation from check fees and mortgage fees is not enough. Banks must develop new products such as financial counseling, insurance products, and other products. Bankers should follow the lead of other professionals such as accountants, attorneys, and physicians and not give their services or products away.

Incentives

A more recent tool to improve earnings is the use of incentives. Most staff members would be reluctant to tell you that they perform better when they are given incentives, but it is a well-established fact. Incentives truly provide a win-win situation for shareholders and staff members, since incentives should only be paid when the bank performance meets the agreed upon standard. Directors should set fair performance standards at the beginning of the year, distributing 20 to 30 percent of the income for performance.

Positive Perception of Bank

What does a positive perception of a bank have to do with profitability? Everything! If a bank is perceived to be a problem institution or for some other reason has a bad reputation, it will have a substantial impact on the bank's ability to attract profitable business. Customers like to do business with quality organizations so their perceptions will play a major role in the selection of a financial institution.

CONCLUSIONS

Banks that conduct regular annual planning sessions and follow-up in the implementation of the plan will position themselves to be successful in today's competitive environment. Banks must conduct all their planning on a dynamic basis and be prepared to act or react rapidly to changes in their markets and changes in the needs of their customers and prospects. There are many challenges to banking in the future, but there are also many opportunities for those financial organizations flexible enough to adapt their planning approaches to meet the demands brought about by the changing banking scene.

REFERENCES

Berry, L. A. (1999), Discovering the Soul of Service (pp.10, 148),New York: Free Press.

Bexley, J. B. (1998), Directors' Duties & Responsibilities in Financial Institutions. Huntsville, TX: Sam Houston Press.

Bexley, J. B. & J. Duffy, (2000), "Adapting Financial Institution Directors' Roles in the Management Process to Achieve a Competitive Advantage: A Challenge for 2000 and Beyond," Advanced Mangement Journal, Society for Advancement of Management, Volume 65, Number 3, Summer 2000.

Business Week, (2000), "University of Michigan's American Customer Service Satisfaction Index," October 23 Issue, New York.

Stratus Technologies, The Bank Strategist, Lexington, Kentucky, 2001.

James B. Bexley, Sam Houston State University

Leroy W. Ashorn, Sam Houston State University

N. Ross Quarles, Sam Houston State University