A Short History of Profitability Analysis in Banks

A new twist on an old chestnut:

A man in a hot air balloon lands in a forest, gets stuck in a tree and, not knowing his whereabouts, looks around. Along walks another guy so the balloon man asks, "Excuse me, can you tell me where I am?"
"Sure," says the other one, "in a tree."
"Oh," says the balloon man, "you must be an accountant."
"As a matter of fact, I am, how did you know?"
"Well, you just gave me a very precise piece of worthless information."
"I see" says the accountant "and you must be a consultant."
"You're right, how did you know?"
"As long as you're up in the air, you seem to know where you're going, but as soon as you get down to earth, you're lost."

There was a time when an experienced banker could count on spreads remaining fairly constant and competition being relatively scarce due to regulatory barriers. Barring credit problems, reasonable profits were not hard to find. At shareholder's meetings, directors and shareholders were more concerned about the menu than they were about returns.

As the banking industry consolidates and transforms into a more diversified financial services industry, however, the traditional models of intuition-based decision-making are less relevant. Even the smallest community banks have to be aware of how their organization produces profits in a detailed way in order to meet the demand for high returns. The time is ripe for management information. As they say, the rules have changed.

Asset/Liability management (ALM) was one of the first major industry movements to provide management insight due to the risk from major swings in interest rates. While ALM is an important source of planning information, it lacks a comprehensive view of the institution. That comprehensive view is what profitability analysis provides.