Monday, May 16, 2016

Irrational Efficiency....

Nothing wrong with being wrong, except when you're sure you are right.

No one has ever purposefully selected "crow" from the menu for a next meal; but "stuff" does happen, lettuce does get lodged in teeth, and flies do get left open.  Grace is when someone is kind enough to end your unrealized humiliation by pulling you to the side and saying: "Oh by the way...."

"Oh by the way", we need to talk about

"The Efficiency Ratio".....

The efficiency ratio is a calculation which compares a financial institution's operating costs to its net interest income & non-interest income.  But, before we go any further with all this, let's clarify one thing for the non-CPAs and non-math majors in the audience.....

This type of financial calculation, this "sophisticated" ratio analysis, this sort of comparison of two numbers, was known as "doing fractions" when you were in the third grade.

That's right another name for a ratio is a fraction; so, hang in there you can do this!

Actually, it's all kind of really silly isn't it; now that you know the dirty little secret that those "serious-minded", "robust" number-crunching preposticators are really just weird little third graders doing fractions ! (But, you suspected that all along anyhow, didn't you !) 

But, anyway back to the story, "Operating costs" are your expenses of running the CU (salaries, rent, utilities, NCUA assessments, etc).  "Net interest income" is the interest you earn on loans and investments less the interest you pay out to members on deposits.  And, "Non-interest income" represents the various fees you receive for services such as NSF, interchange, safe deposit box, mortgage origination, etc. You can add some other variations and "refinements" to the calculation, if you like to over-complicate problems for no particular purpose, but.....

The efficiency ratio implies that the lower your expenses are compared to your total net income - the more efficient a credit union you operate.  The ratio works well as a standard benchmark in the world of banking, therefore it must make sense for credit unions also - right?

Well, let's analyze the two parts  (operating expenses / total net income) of this ratio-fraction a little bit. First, no one can much object to the expense piece, because we all agree that you should constantly work to lower your operating expenses whenever possible.  And, in the long run in business, if we are offering products of similar kind & quality; the firm with the lowest cost will win.

The problem for credit unions arises with the second part of the fraction - total net incomeWhat's the problem?  The efficiency ratio assumes that a credit union will, like its banking peers, diligently attempt to maximize profits and thereby always try to maximize total net income.  The more you can increase total net income while keeping expenses stable, the lower your efficiency ratio-fraction (which means "better"!) will become.  

The problem is most of us actually spend a great deal of time trying to minimize total net income by "givingback" to the members through better (which means "lower") loan rates and fees - and higher savings rates.

Perhaps I've lost you at this point, so just cogitate on this question:  

Is your goal as a credit union leader to maximize profits by increasing interest rates on loans whenever possible, by paying your members a miserly rate on savings, and by slipping in a fee increase at every opportunity?  

Well, if you answered "NO" to any of those three questions - you're inefficient! But being "inefficient" from a "profit maximizers" perspective is at heart what being a credit union is all about. So, keep it up! 

But be careful, we have a lot of dangerous third grade fractioneers running around who are very much in need of an "Oh by the way..."

Don't let them bully you on the playground; 
hopefully they'll grow out of it....

1 comment:

Anonymous said...

The member first way of doing business is admirable but one would be remiss if they did not admit to the fact that there are countless credit union CEO's who are driven to show the highest of incomes simply because their bonuses are tied to that number.And don't think these money grabbing individuals are unaware of the value of fee income to the bottom line and their pocket books. If you track the fees credit unions charge to their members you would find they mirror those of banks and overdraft charges are worse than taking out a payday loan. For every credit union that is there for their members there is at least one that is there for the CEO.