Organizational profitability helps institutions measure financial performance, identify revenue sources, and expense drivers. This often includes a breakdown of performance across different lines of business, branches, geographic areas, and departments. These insights help institutions better understand what drives a bank or credit union’s performance and ultimately profitability.

Increased visibility and understanding of revenue and expense sources helps banks and credit unions make informed decisions and allocate resources more effectively. As discussed in Empyrean’s organizational profitability webinar, profitability should serve as a proactive management tool, rather than functioning only as a historical reporting tool.

What Is Organizational Profitability?

Organizational profitability enables banks and credit unions to measure financial performance across multiple segments or dimensions. Common segments include lines of business, branches, markets, and departments.

The process attributes net interest margin, non-interest income and expense, and capital to each segment. As a result, bank and credit union leaders can identify which areas contribute most to overall profitability.

Organizational profitability provides actionable insights into how a bank should most effectively allocate its resources and invest its capital to maximize performance. This differs from traditional accounting and related reporting, where those details are not available.

Why Organizational Profitability Matters for Banks and Credit Unions

Organizational profitability provides transparency into the specific factors that are contributing to financial performance. Examples include funding costs, margin, fee income, staffing expenses, other operational expenses, and capital usage. Teams can use these insights to determine what supports or inhibits profitable growth.

With more visibility into these drivers, organizations can make strategic decisions more confidently. This is becoming increasingly important as banks and credit unions respond to a fast-paced and ever-changing banking environment. Expanding into new markets, pricing adjustments, marketing efforts, and staffing allocations are all examples of common decisions that can be made more confidently and accurately.

Organizational vs. Instrument-Level Profitability

Organizational and instrument-level profitability each provide banks and credit unions with tools to measure financial performance:

• Organizational profitability provides a framework to measure and analyze profitability at higher levels within the organization, grouping together performance metrics by line of business, branch, departments, and market segments.
• Instrument-level profitability enables the measurement and analysis of profitability at the individual customer loan and deposit level, expanding analysis to customer, relationship, officer and product levels.

For many banks and credit unions, organizational profitability provides the data necessary to determine general trends and patterns, without requiring complex loan-level modeling. Banks and credit unions can then use those insights to determine optimal channel strategies, pricing levels, and operational efficiencies.

How Banks and Credit Unions Use Organizational Profitability in Practice

Banks and credit unions use organizational profitability to determine which areas of the company are contributing to its financial performance. Rather than looking at aggregated institution-wide metrics, this framework allows institutions to drill down into the performance details of multiple segments and channels.

For example, profitability analysis may reveal that branches in certain geographic areas exhibit stronger metrics for loan margins and volumes in combination with lower overall expenses.

With this insight, teams can further strengthen the performance of branches in those areas by:

• Evaluating the underlying reasons.
• Adopting a similar strategy in other markets.
• Reallocating resources.

How to Build an Organizational Profitability Framework

Banks and credit unions can improve performance analysis by establishing simple, consistent profitability measurement processes. These processes can then be further refined over time as reporting needs change.

The following steps can help build a strong organizational profitability framework:

• Define the Scope of Organizational Analysis: Determine which segments the bank wants to measure and analyze (departments, lines of business, channels, markets) and how profitability is to be measured across the entire organization. The methodology applied should align with how performance is measured for the overall bank and by senior management.
• Measure Net Interest Margin: Funds transfer pricing (FTP) is commonly used to determine the allocation of interest income and expense across the organization. Net interest margin is typically the largest driver of revenue for banks and credit unions, and FTP improves the accuracy of margin measurement as part of the profitability equation.
• Allocate Non-Interest Revenue and Expenses: Ensure all items contributing to revenue and expenses are considered. This can include items such as operating expenses, third-party costs, fee income, and other direct and indirect income and expense sources.
• Allocate Capital: Risk-Adjusted Return on Capital (RAROC) provides the best comparative profitability metric. Considering various risk factors, including credit risk, market risk, operational risk, and allowance (ACL), in the allocation of capital enables the consideration of inherent risks the bank takes in generating its profitability across the various segments. 
• Ensure Consistent Application of Rules: Applying rules consistently can eliminate discrepancies and allow for results to be interpreted with greater accuracy and confidence over time.
• Analyze Results: Results should guide strategic decisions about pricing, growth plans, marketing, staffing, and resource management. Results should also be tracked and analyzed over time to determine their effectiveness and how the process can be improved.

Why Transparency Is Critical in Profitability Analysis

Transparency is critical for ensuring accuracy in results, but also for building trust across teams. Departments must each understand how profitability results are calculated to confidently use them in making strategic decisions.

Institutions should ensure that they can explain how various costs and revenue figures are allocated across different teams, branches, and business units. Consistent methodologies and allocation logic are key to ensuring no items are overlooked or duplicated.

This is best achieved by including leaders from across the organization throughout the profitability initiative (from inception to design and rule definition, to interpretation of results). It creates more buy-in to the process, results and use of data to make better decisions. 

This level of transparency also streamlines audits and can improve stakeholder confidence. With clearly documented rules and methodologies, institutions can more effectively support regulatory reviews and identify discrepancies in management discussions.

Breaking Down Silos With Profitability Insights

Organizational profitability helps reduce departmental silos because it creates a shared view of financial performance across the entire bank. By comparison, teams that work in silos may not work with consistent data, leading to discrepancies in metrics and assumptions.

By unifying teams under the organizational profitability framework, teams can be aligned on company goals surrounding performance metrics, growth, operational processes and related costs, and other strategic decisions. This helps eliminate conflicting priorities among teams.

Profitability insights also increase transparency and accountability. When performance can be measured more consistently and accurately across teams and product lines, managers have more visibility into what is driving results. They can then use this information to determine where and how to improve results going forward.

Connecting Profitability to Planning and ALM

When combined with other functions such as asset liability management and planning, organizational profitability becomes an even more valuable tool.

For example, by applying profitability allocation rules to a budget, banks and credit unions can create a fully allocated budget that reflects all costs and expected returns across multiple teams, branches, departments, and product lines.

This further supports other initiatives in the budgeting process in banks and credit unions by improving visibility and targets related to projected performance.

Turn Profitability Insights Into Action With Empyrean

Organizational profitability can drive better decisions for an institution. However, many banks and credit unions struggle to transition from insight to action because the data often lies in separate, disconnected systems.

Empyrean helps institutions solve this challenge through the use of its unified platform, including solutions for Profitability Measurement and Analysis, Matched-Term Funds Transfer Pricing, Budgeting & Planning, ALM and CECL. This platform creates a unified environment that can connect multiple teams and functions with access to the same data, while providing a comprehensive profitability measurement and analysis process as part of that platform.

Explore Empyrean Profitability to see how we help banks and credit unions improve strategic planning. You can also request a demo to see how our platform supports profitability workflows.

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