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Capital Assignment and Risk-Adjusted Return on Capital ("RAROC")
Traditional measures of profitability like return on assets (ROA)
do not provide insight into the deposit-gathering side of the business,
let alone non-fund products such as insurance sales and brokerage services.
Risk-Adjusted Return on Capital (RAROC) has become the industry standard
for evaluating an institution with a diverse set of services.
While the allocation of capital in a profitability model should
complement a risk management and capital adequacy framework, there is a
noteworthy difference. Regulatory frameworks, such as those provided by
the governing regulatory bodies, are primarily developed to measure the
safety and soundness of an institution. While they are an excellent
starting point, they might not fully reflect the economic value created
(or destroyed) by organizational units, lines of business, product,
officers, and customers.
Clients have the flexibility of performing their own risk assessment or
using guidelines developed by TKG. We have performed a number of these
assessments and can offer constructive suggestions to an institution
just beginning the capital allocation process. In many cases,
institutions do not consider allocating capital to lines of business
such as deposit gathering. Given the need to evaluate business units
independently, and the very real risks associated with those activities,
this becomes necessary.
What TKG Offers:
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Assignment of allocated capital adjusted for risk to organizational
units, lines of business, branches, products, officers, and customer
accounts.
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Calculation of Return on Equity at the product and account-level which
feeds into your existing MCIF and/or CRM systems.
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Best practice Capital Allocation approach and methodology.
How You Benefit:
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Identify products and lines of business that enhance and create
shareholder value from those that destroy shareholder value.
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Improve your overall return on equity by identifying which asset
products and lines of business should receive more or less of the
financial institutions limited supply of fund sources, either deposits,
borrowings, and/or equity.
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Cost Assignment
Cost assignment within financial institutions requires a realistic,
credible methodology for allocating the dominant category of
non-interest expense: salary and related expense. It follows that time
expended by work-related task activity must be measured and associated
with profitability reporting objectives in order to allocate
compensation-related costs. Human factors come into play. Overly
intrusive “work measurement” techniques can disturb staff work flow.
Simplistic statistics-based approaches will lack accuracy. TKG solves
this issue by utilizing an “activity-based costing” (ABC) approach
located between these extremes: basically, brief structured interviews
with departmental managers and having line staff (lenders, branch staff,
etc.) fill in Web based time estimate surveys. Impact on any one staff
member is minimal. Our process values the unique insight of bank staff
to enhance data, without disturbing the daily work flow.
TKG approaches assignment of non-salary costs using best practice
industry methodology. Categories of these costs include: IT costs,
electronic banking/internet costs, loan loss provision, etc. These cost
assignments, along with the salary and related assignments described
above, yield very actionable cost information. We document and automate
the assignment process by utilizing powerful software tools along with
double-entry allocation accounting in order to provide clients with
clear "drill-down's" and audit trails describing the assignment process.
The process is "full absorption" – nothing is hidden – all costs are
allocated.
TKG will also utilize the ABC approach described above to develop "unit
costs". These costs are frequently used in customer profitability
systems. Each customer is billed for the resources they consume based on
a number of different unit costs. For example, you might determine the
cost per new loan, teller transaction, ATM withdrawal, etc. Most of our
customers choose systems that allocate costs directly to products and
organizational units using resource consumption guidelines, but some
customers elect to develop unit costs for use in MCIF or other systems.
What TKG Offers:
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Measurement and alignment of costs in order to assess the profitability
performance of organizational units, lines of business, branches,
products, officers, and customer accounts.
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Unit costs at the product and account-level which feed into your
existing MCIF and/or CRM systems.
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Best practice activity-based Cost Assignment approach and methodology.
How You Benefit:
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Identify profitable or unprofitable organizational units, lines of
business, branches, products, officers, and customer accounts.
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Improve your efficiency ratio by identifying negative trends in your
direct, indirect, and general corporate overhead components of the
non-interest expenses.
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The Kafafian Group, Inc.
2001 Route 46, Suite 209
Parsippany, NJ 07054
Telephone: 973-299-0300
Fax: 973-299-1002
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What's New
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Message From The President
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Teaching and Speaking Engagements
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Pennsylvania Bankers Association
PBA Advanced School of Banking
Penn State
State College, PA - July 11-16
How do Banks Make Money?
Pennsylvania Bankers Association
PBA School of Commercial Lending
Penn State
State College, PA - July 25-30
Problem Loans
Maryland Bankers Association
The Maryland Banking School
University of Maryland
College Park, MD - August 1-6
Bank Financial Principles
Financial Managers Society
Controllers Clinic
Hotel Sax Chicago
Chicago, IL - August 16-17
Improving the Budgeting Process
Pennsylvania Association of Community Bankers
133rd Annual Convention
The Breakers
Palm Beach, FL - August 28-31
Making More Products and Lines of Business Profitable
PNC Bank
FIG Client Conference
Skytop Lodge
Skytop, PA - September 14-16
The Current State of Community Bank Profitability and Performance
Maine Bankers Association
Annual Convention
Mount Washington Resort
Bretton Woods, NH - September 17
Profitability and Performance Measurement
PICPA
Harrisburg, PA - September 27
Profitability and Future Trends in Banking
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Thank you for visiting The Kafafian Group’s ("TKG") web-site. We trust it will
help you find the information you are searching for to make informed decisions
about the products and services offered by our Company. In addition, our web-site
provides educational content which is intended to be useful to you in managing and
operating your business.
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TKG and our predecessor companies have been assisting financial institutions since
1982. Our primary services include performance measurement, strategic and business
planning, profit/process improvement, and financial advisory for banks, thrifts, and
credit unions. We are also active participants in numerous state and national
banking associations, speakers on a variety of subjects, faculty members at many
banking schools, and have written books, journals and articles. Our staff is
uniquely qualified in multiple banking disciplines, all having previously worked
in financial institutions, and we are often quoted as industry experts by many
publications.
If you have any questions or comments, please feel free to call me at 973-299-0300,
extension 106, or contact me at
We look forward to hearing from you.
Bob Kafafian
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