BY CULLEN COXE AND STACEY WILKERSON
What lies at the foundation of your credit union’s success? The answer to that question isn’t always easy to gauge. Our currency experts have identified six pillars that underpin optimal CU performance. Learn what these pillars are and how they can transform your credit union into a high-performing financial institution.
Improving performance is a common goal that all financial institutions share. Achieving optimal performance, even accurately measuring success, can be challenging. Therefore, it’s important to identify, understand and manage the foundational elements of what makes a financial institution successful.
ALM First has identified six pillarsof high-performing financial institutions: capital, pricing, funding, management, risk and profit. Viewed simply, these pillars can also be thought of as levers. Financial institutions regularly evaluate these levers to optimize profitability in the balance sheet, where decisions involve pushing down or pulling back combinations of various levers. High-performing institutions are persistently seeking opportunities for excess basis points by identifying and capitalizing on new opportunities.
As the credit union industry adopts risk based capital (RBC), financial institutions are faced with balancing regulatory, dual-capital mandates. As a result,efficient allocation of capital is a vital part of capital management because it relates to the overall balance sheet. Although a financial institution’s allowance for loan loss and provisions held on the balance sheet must be adequate to cover expected losses caused by normal operating conditions, capital must also be available to absorb any additional expected or unexpected losses. Capital is essential to reduce systemic risk and to protect depositors as well as federal or private insurance funds.
But if capital is so important, shouldn’t all financial institutions strive to hold large amounts on their balance sheets? Of course, regulators would prefer institutions to hold large amounts of capital.That’s because doing so moves the put-option of the credit union farther away from affecting the deposit insurance funds. In reality, it just transfers some of the risk from the insurance fund to the owners of the capital. On the flip side, shareholders/members expect their institutions to hold less capital so they can leverage profitability; holding excess capital can be expensive if it isn’t deployed in a timely, efficient manner. An institution holding excess capital must take on incremental risk to earn higher profits. All else equal, this is necessary to generate the same return on equity (ROE). As a metric, ROE(net income divided by equity) measures how effectively the institution utilizes the invested capital.