3 Steps to Improve Planning Accuracy for Financial ......Using CCFMP, organizational profitability...

3 STEPS TO IMPROVE PLANNING ACCURACY FOR FINANCIAL INSTITUTIONS

© 2019 Kaufman, Hall & Associates, LLC 1

3 Steps to Improve Planning Accuracy for Financial Institutions

© 2019 Kaufman, Hall & Associates, LLC

FINANCIAL INSTITUTIONS



Introduction

Balancing Efficiency and Accuracy in Bank Budgeting ProcessOne of the most difficult aspects of the budgeting process for any financial institution is for management to decide the optimal trade-off between expediency and accuracy. This is most evident when choosing how to plan balance sheet items and their net interest margin.

“Expediency” and the Average Balance-Average Rate Approach

If management decides to go the “expedient way,” the institution will choose an “average balance-average rate approach,” in which budget inputs are based on where the department manager believes their volumes and rates will be with no regard to what current volumes (and their runoffs) have on their position.

“Accuracy” and the Cash Flow Approach

If management decides to use a more “accurate” approach, they will use a “cash flow” method, where the current balance sheet position runs off over the budgeting time horizon based on the account’s characteristics. A variation of this method is to download results from an Asset/Liability system, and although very accurate, this method also has its challenges.



WHY TRADITIONAL APPROACHES FAIL

Shortcomings of traditional approaches to projectionsThere are numerous approaches that institutions have traditionally employed to produce net interest income/margin and balance sheet projections for the annual plan or periodic forecast. These approaches include:

• Planning for volumes only, not pricing or rate changes – This method omits any realistic margin calculations.

• Using the ALM forecast generated for the consolidated institution – Not typically calculated at the individual business unit level, therefore this method does not show a realistic view of individual unit contributions to budget results.

• Leveraging an ALM projection and allocating the margin to the associated units within the organization – Although a more accurate indication of the business unit, the allocation methodology can be difficult and lend itself to misleading results.

• Planning at the profit center level with ‘simple rate times balance’ math – This common methodology lends little accuracy in the resulting margin calculation.



WHY INSTITUTIONS CHOOSE COLLABORATIVE CASH FLOW MARGIN PLANNING

Benefits of cash flow planning

Collaborative cash f low margin planning (CCFMP) is a marriage between ALM and traditional f inancial planning approaches. More and more institutions are turning to this approach because of its many benefits, including:

• Greater precision with regard to balances, net interest income and margin projections

• Increased accountability – line of business stakeholders own the plan

• Provides better focus on incremental new business – both volume and spread

• Inclusion of forward-rate funds transfer pricing, so that business units can plan the margin contribution through time

• Stronger modeling capabilities such as the ability to process meaningful “what if” scenarios

• Greater insight into balance sheet and margin performance



Leverage coretransaction system data

Ensure your institutionmakes the cultural shift

Complete your balancesheet plan

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WHY INSTITUTIONS CHOOSE COLLABORATIVE CASH FLOW MARGIN PLANNING

Critical steps to successful cash flow planningInstead of modeling one enterprise balance sheet as ALM typically does, CCFMP creates tens, hundreds, or even thousands of planning unit balance sheets – each reflective of the product mix, pricing and other nuances of the local markets they serve. With the incorporation of forward funds transfer pricing (FTP), CCFMP is positioned to include economic capital allocations, service transfer costs and other features that allow each planning unit to be measured on a risk-adjusted return basis. Using CCFMP, organizational profitability can be merged with the planning process, thereby applying a consistent view of the business regardless of whether it is forward or backward looking. The absence of forward rate FTP and a cash-flow based planning methodology such as CCFMP negates any ability to merge these views.

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Leverage core transaction system data

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It all starts with the underlying data from your core transactions systems. Extract the relevant data fields from, for example, loans and deposit systems, and feed them into a cash flow preprocessor, where cash flows for each record will be generated.

In the diagram below, a mortgage loan record is processed and principal cash flows (including any prepayments) are generated for the budget period. This includes not only principal cash flows but additionally, monthly interest income and if desired, FTP expense.

The preprocessor should then aggregate all accounts according to the institution’s defined dimensionality (e.g. product and branch or loan center) and feed them as the starting position for the planning unit’s budget. This does not add any complexity to the budget user’s routine, as the preprocessor generated their starting position for them.



Complete your balance sheet plan

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Once all cash f lows have been generated and aggregated into portfolios, individual planners can go into their budget and complete their balance sheet plan.

In the example below, users would enter their adjustments to the global growth percentage of 4%. This could be an additional percentage or volumes in specific forecasted months. It is important that the planning system can support both top down and bottom up planning approaches. Such a design allows administrators to alter global assumptions and individual planners to alter their assumptions simultaneously without conflict.



Ensure your institution makes the cultural shift

3The cash flow based methodology combines the existing “current position cash flows” with the forecasted new volumes and measures associated runoff, calculating periodic balances and income for the entire portfolio. This is of great benefit to the user and to management alike.

Users

This methodology requires minimal effort from the end-users. They essentially manage by exception, focusing on those portfolios where minor adjustments to the global assumptions are needed. This leads to more accurate results by mirroring actual portfolio characteristics in your budget processing and capturing portfolio nuances. If the institution uses a more simplified approach (such as inputting average balances and average rates), they give up a great deal of precision and they lose sight of the new business necessary to meet targets.

Management

This approach also requires minimal ef fort from management. Generating a new version of the budget after making a change such as changing a global assumption (e.g. adjusting the growth rate from 4 percent to 5 percent), is very easy in this paradigm without any of the individual user’s intervention.

Utilizing cash flow planning in the budget process will provide your institution with more of an Asset/Liability Management approach to budgeting without making the process more complicated. But, it is still incredibly flexible and more accurate at predicting your performance.



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3 Steps to Improve Planning Accuracy for Financial ......Using CCFMP, organizational profitability...

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