Tag: bank

If it looks like a bank and acts like a bank, there’s a good chance the company behind that financial services transaction may not actually be a bank – but a fintech. Born out of Silicon Valley, New York and tech hubs in between, fintechs have been categorically unfettered from regulation and driven by a focus on customer acquisition and revenue growth. Today, the fintech market represents hundreds of billions of dollars globally and has been disrupting financial services with the goal of delightful customer experiences and democratizing access to credit and banking. Their success has led many fintechs to update their strategy and growth targets and set their sites outside of core banking to other sectors including payments, alternative lending, insurance, capital markets, personal wealth management, alternative lending and others. Depending on the strategy, many are seeking a bank charter, or a partnership with a chartered financial institution to accomplish their new growth goals. Meanwhile, all this disruption has caught the attention of banks and credit unions who are keen to work with these marketplace lenders to grow deposits and increase fee-revenue streams. Historically, obtaining a bank charter was an onerous process, which led many fintechs to actively seek out partnerships with financial institutions in order to leverage their chartered status without the regulatory hurdles of becoming a bank. In fact, fintech and FI partnerships have boomed in the last few years, growing more than five times over the past decade. Gone are the days of the zero-sum game that benefits solely the bank or the fintech. Today, there are more than 30 partner banks representing hundreds of fintech relationships and financial services. These partnerships vary in size and scope from household names like Goldman Sachs, which powers the Apple credit card, to Hatch Bank, which has $68 million in assets and started with a single fintech partner, HM Bradley.[1] But which scenario is right for your fintech? Much of that depends on which markets and lines of business round out your growth strategy and revenue goals. Regardless of what framework you determine is right for your fintech, you need to work with partners who have access to the freshest data and models and a firm handle on the regulatory and compliance landscape. Experian can help you navigate the fintech regulatory environment and think through if partnering with a bank or seeking your own fintech charter is the best match for your growth plan. In the meantime, check out this new eBook for more information on the bank charter process and benefits, fintech-FI partnerships and the implications of the Office of the Comptroller of the Currency (OCC) new fintech charter. Read now Explore Fintech solutions   [1] https://a16z.com/2020/06/11/the-partner-bank-boom/

The CU Times recently reported on a nationwide synthetic identity fraud ring impacting several major credit unions and banks. Investigators for the Federal and New York governments charged 13 people and three businesses in connection to the nationwide scheme. The members of the crime ring were able to fraudulently obtain more than $1 million in loans and credit cards from 10 credit unions and nine banks. Synthetic Identity Fraud Can’t Be Ignored Fraud was on an upward trend before the pandemic and does not show signs of slowing. Opportunistic criminals have taken advantage of the shift to digital interactions, loosening of some controls in online transactions, and the desire of financial institutions to maintain their portfolios – seeking new ways to perpetrate fraud. At the onset of the COVID-19 pandemic, many financial institutions shifted their attention from existing plans for the year. In some cases they deprioritized plans to review and revise their fraud prevention strategy. Over the last several months, the focus swung to moving processes online, maintaining portfolios, easing customer friction, and dealing with IT resource constraints. While these shifts made sense due to rapidly changing conditions, they may have created a more enticing environment for fraudsters. This recent synthetic identity fraud ring was in place long before COVID-19. That said, it still highlights the need to have a prevention and detection plan in place. Financial institutions want to maintain their portfolios and their customer or member experience. However, they can’t afford to table fraud plans in the meantime. “72% of FI executives surveyed believe synthetic identity fraud to be more challenging than identity theft. This is due to the fact that it is harder to detect—either crime rings nurture accounts for months or years before busting out with six-figure losses, or they are misconstrued as credit losses, and valuable agent time is spent trying to collect from someone who doesn’t exist,” says Julie Conroy, Research Director at Aite Group. Prevention and Detection Putting the fraud strategy discussion on hold—even in the short term—could open up a financial institution to potential risk at time when cost control and portfolio maintenance are watch words. Canny fraudsters are on the lookout for financial institutions with fewer protections. Waiting to implement or update a fraud strategy could open a business up to increased fraud losses. Now is the time to review your synthetic identity fraud prevention and detection strategies, and Experian can help. Our innovative new tool in the fight against synthetic identity fraud helps financial institutions stop fraudsters at the door. Learn more  

With jobs losses mounting and the prospects for a quick economic rebound fading, some segments of the financial markets are beginning to bet that the Federal Reserve will take interest rates negative for the first time in U.S. history. If that happens, it could have a profound impact on the U.S. economy, and more specifically, on financial institutions. While other nations such as Denmark, Japan, Sweden, and Switzerland have experimented with negative rates over the years, the U.S. has shied away – both for political and economic reasons. Instead, when interest rates are near zero, the Fed prefers to use a mix of large-scale asset purchases and forward guidance to support the economy. In the current crisis, the Fed has also launched several new emergency lending programs to ensure the smooth functioning of the financial system. The question remains, however, if these tools will be enough to keep the U.S. out of a deep recession, especially if Congress fatigues on further fiscal support. The Fed is independent but keep an eye on the markets In his May 13th remarks to the Peterson Institute for International Economics, Fed Chairman Jerome Powell said that he and the rest of the rate-setting committee unanimously shared the same view on negative rates: “For now, it is not something we are considering”. While some market watchers looked for clues in the “for now” phrasing, it was clear from the rest of his remarks that the bar for enacting negative rates was set very, very high. However, despite the Fed having independence in its policy-making decisions, financial markets and to some extent, politics, still have influence. And there is precedent for markets exerting pressure on the Fed and perhaps even getting their way. In 2013, when then-Fed Chairman Ben Bernanke made a surprise announcement that the Fed would reduce the level of asset purchases, global financial markets went into a frenzy. That period, now known as the “Taper Tantrum”, altered the way the Fed signals its policy actions. More recently, the big declines in equity markets in late 2018 were seen by many as a primary driver in the Fed’s sudden U-turn from raising rates four times that year to lowering them three times in 2019. Now, with equity markets wanting more stimulus and traders in fed fund futures appearing to anticipate negative rates from the central bank in early 2021, there is concern that the markets are trying to bully their way again. And with the president’s renewed call for the Fed to take rates negative, there is some reason to believe that “not now” could become “now” sooner than many expect. Concerns for financial institutions While several central banks have resorted to negative interest rate policy for years, the efficacy of its use is unclear. But what is clear, is that financial institutions bear the greatest burden in implementing the policy. Currently in the U.S., banks earn interest on excess reserves held at the Fed. Negative rates would essentially flip the script and penalize this practice, forcing banks either to pay the Fed interest or do something else with the money. The hope is that this will encourage banks to make more loans and stimulate the economy. However, as Fed Chair Powell said in his remarks, he believes that negative rates could have the opposite effect and curtail lending. Since negative rates would put a downward pressure on interest rates across the board, the net interest margin – the spread banks make between what they pay depositors and what they charge for loans – would be compressed and profitability would sink. If banks and other financial institutions are struggling, credit availability could decline when it is needed the most. Why it matters Financial institutions cannot ignore the possibility of negative interest rates in the U.S. as it would have wide-ranging effects and potentially significant consequences. And while Fed officials have said they are not considering negative rates, the notion is not totally off the table. As the famous economist, Stanley Fischer, advised his fellow central bankers in his well-known piece “Central Bank Lessons from the Global Crisis”: “In a crisis, central bankers (and no doubt other policymakers) will often find themselves deciding to implement policy actions that they never thought they would have to undertake – and these are frequently policy actions that they would prefer not to have to undertake. Hence, a few final words of advice for central bankers: Never say never.”

For financial marketers, long gone are the days of branded coffee mugs, teddy bears and the occasional print ad. Financial marketers are charged with customizing messaging and offerings at a customer level, increasing conversion rates, and moving beyond digital while keeping an eye on traditional channels. Additionally, financial marketing teams are having to do it all with less; according to CMO Survey, marketing budgets have remained stagnant for the last 6 years. Accordingly, competing in today’s world requires transforming your organization to address rapidly increasing complexity while containing costs.  Here are four tactics leading-edge firms are using to respond to changes in the market and better serve customers. More data, fewer problems Financial institutions ingest a mind-boggling variety of data, transaction details, transaction history, credit scores, customer preferences, etc. It can be difficult to know where to start or what to do with what is often terabytes of data. But the savviest teams are mining their unique data, along with bureau data, and other alternative and third-party data for rich decision making that drives differentiation. Getting analytical In financial institutions, advanced analytics has traditionally lived with lenders, underwriters, risk and fraud, departments, etc. But marketers too can find the value in the volume, velocity and variety of new data sources available to financial institutions. Using advanced analytics allows the most forward-thinking financial marketers to better target customers, personalize experiences, respond in near-real-time or even predict actions, and measure the impact of marketing investments. Customized quality time with customers Thanks to the likes of Google and Amazon, consumers have become accustomed to individualized interactions with firms they utilize. And this desire is just as present when it comes to their financial institution. But banks, credit unions and fintechs have been historically slow to respond. According to a recent Capgemini study, 70% of US consumers feel like their financial institution doesn’t understand their needs. The most dynamic financial marketing teams tailor quality experiences that increase consumer engagement and long-term relationships. All the channels, all the time The financial marketer’s job doesn’t stop at creating bespoke experiences for customers. Firms are also having to leverage an omnichannel approach to reach these clients, across an ever-growing number of channels and touchpoints. If that wasn’t enough, campaign cycles are shortening to match consumers changing demands and need for instant gratification—again, thanks Amazon. But the best teams determine which media or interaction resonates most effectively with clients, whether face-to-face, via an app, chatbot, or social media and have conversations across all of them seamlessly. It’s clear, financial firms must transform their approach to address increasing market complexity without increasing costs. Financial marketers are saddled with stagnant marketing budgets, proliferating media channels and shorter campaign cycles, with an expectation to continue delivering results. It’s a very tall order, especially if your financial institution is not leveraging data, analytics and insights as the differentiators they could be. CMOs and their marketing teams must invest in new technologies, strategies and data sources that best reflect the expectations of their customers. How is your bank or credit union responding to these financial marketing challenges? Watch our 2020 Credit Marketing Trends On-Demand Webinar  

Last month, Kenneth Blanco, Director of the Financial Crimes Enforcement Network, warned that cybercriminals are stealing data from fintech platforms to create synthetic identities and commit fraud. These actions, in turn, are alleged to be responsible for exploiting fintech platforms’ integration with other financial institutions, putting banks and consumers at risk. According to Blanco, “by using stolen data to create fraudulent accounts on fintech platforms, cybercriminals can exploit the platforms’ integration with various financial services to initiate seemingly legitimate financial activity while creating a degree of separation from traditional fraud detection efforts.” Fintech executives were quick to respond, and while agreeing that synthetic IDs are a problem, they pushed back on the notion that cybercriminals specifically target fintech platforms. Innovation and technology have indeed opened new doors of possibility for financial institutions, however, the question remains as to whether it has also created an opportunity for criminals to implement more sophisticated fraud strategies. Currently, there appears to be little evidence pointing to an acute vulnerability of fintech firms, but one thing can be said for certain: synthetic ID fraud is the fastest-growing financial crime in the United States. Perhaps, in part, because it can be difficult to detect. Synthetic ID is a type of fraud carried out by criminals that have created fictitious identities. Truly savvy fraudsters can make these identities nearly indistinguishable from real ones. According to Kathleen Peters, Experian’s SVP, Head of Fraud and Identity, it typically takes fraudsters 12 to 18 months to create and nurture a synthetic identity before it’s ready to “bust out” – the act of building a credit history with the intent of maxing out all available credit and eventually disappearing. These types of fraud attacks are concerning to any company’s bottom line. Experian’s 2019 Global Fraud and Identity Report further details the financial impact of fraud, noting that 55% of businesses globally reported an increase in fraud-related losses over the past 12 months. Given the significant risk factor, organizations across the board need to make meaningful investments in fraud prevention strategies. In many circumstances, the pace of fraud is so fast that by the time organizations implement solutions, the shelf life may already be old. To stay ahead of fraudsters, companies must be proactive about future-proofing their fraud strategies and toolkits. And the advantage that many fintech companies have is their aptitude for being nimble and propensity for early adoption. Experian can help too. Our Synthetic Fraud Risk Level Indicator helps both fintechs and traditional financial institutions in identifying applicants likely to be associated with a synthetic identity based on a complex set of relationships and account conditions over time. This indicator is now available in our credit report, allowing organizations to reduce exposure to identity fraud through early detection. To learn more about Experian’s Synthetic Fraud Risk Level Indicator click here, or visit experian.com/fintech.

What is CECL? CECL (Current Expected Credit Loss) is a new credit loss model, to be leveraged by financial institutions, that estimates the expected loss over the life of a loan by using historical information, current conditions and reasonable forecasts. According to AccountingToday, CECL is considered one of the most significant accounting changes in decades to affect entities that borrow and lend money. To comply with CECL by the assigned deadline, financial institutions will need to access much more data than they’re currently using to calculate their reserves under the incurred loss model, Allowance for Loan and Lease Losses (ALLL). How does it impact your business? CECL introduces uncertainty into accounting and growth calculations, as it represents a significant change in the way credit losses are currently estimated. The new standard allows financial institutions to calculate allowances in a variety of ways, including discounted cash flow, loss rates, roll-rates and probability of default analyses. “Large banks with historically good loss performance are projecting increased reserve requirements in the billions of dollars,” says Experian Advisory Services Senior Business Consultant, Gavin Harding. Here are a few changes that you should expect: Larger allowances will be required for most products As allowances will increase, pricing of the products will change to reflect higher capital cost Losses modeling will change, impacting both data collection and modeling methodology There will be a lower return on equity, especially in products with a longer life expectancy How can you prepare? “CECL compliance is a journey, rather than a destination,” says Gavin. “The key is to develop a thoughtful, data-driven approach that is tested and refined over time.” Financial institutions who start preparing for CECL now will ultimately set their organizations up for success. Here are a few ways to begin to assess your readiness: Create a roadmap and initiative prioritization plan Calculate the impact of CECL on your bottom line Run altered scenarios based on new lending policy and credit decision rules Understand the impact CECL will have on your profitability Evaluate current portfolios based on CECL methodology Run different loss methods and compare results Additionally, there is required data to capture, including quarterly or monthly loan-level account performance metrics, multiple year data based on loan product type and historical data for the life of the loan. How much time do you have? Like most accounting standards, CECL has different effective dates based on the type of reporting entity. Public business entities that file financial statements with the Security and Exchange Commission will have to comply by 2020, non-public entity banks must comply by 2022 and non-SEC registered companies have until 2023 to adopt the new standard. How can we help: Complying with CECL may require you to gather, store and calculate more data than before. Experian can help you comply with CECL guidelines including data needs, consulting and loan loss calculation. Experian industry experts will help update your current strategies and establish an appropriate timeline to meet compliance dates. Leveraging our best-in-class industry data, we will help you gain CECL compliance quickly and effectively, understand the impacts to your business and use these findings to improve overall profitability. Learn more

With the number of consumer visits to bank branches having declined from 52% of people visiting their bank branch on a monthly basis to 32% since 2015, the shift in banking to digital is apparent. Rather than face-to-face interaction, today’s financial consumers value remote, on-demand, services. They expect instant credit decisioning, immediate account funding, and around-the-clock customer assistance. To adapt, financial service providers see the necessity to respond to consumers’ growing expectations and become part of their overall digital lifestyle. Here are a few ways that financial services can adjust to changing consumer behavior: Drive mobile app activity With more than 50% of the world’s population actively using smartphones, the popularity of mobile banking apps has soared. Mobile apps have revolutionized the banking sector by facilitating easier communication between clients and institutions, offering value-added services, and introducing blockchain technologies. Consumers use mobile banking apps to pay bills, transfer funds, deposit checks, and make person-to-person payments. In fact, according to a study by Bank of America, more than 60% of millennials use mobile apps to make person-to-person payments on a regular basis! Financial institutions who launch new, or invest in enhancing existing mobile apps, can lower their overall costs, increase ROI, and maintain customer loyalty. Provide convenience and rewards CGI conducted a survey on emerging financial consumer trends, focusing on bank customers’ top requirements. Results confirmed that 81% of respondents expected to receive some form of an incentive from their primary banks. Today’s financial consumers may reasonably be won over by service offerings. They want rewards, limited fees, and convenience. As an example, Experian’s Text for CreditTM simplifies the credit process by providing customers with instant credit decisioning through their mobile devices. Personalized offers based on customer behavior can help enhance your brand and attract new customers. Stay connected Today’s consumers expect instant service and gratification. Consumers prefer to work with banks who offer accessible and responsive customer service. According to a recent NGDATA consumer banking survey, 41% of banking customers report that poor customer service is the primary reason they would leave their bank. Mintel suggests developing an omnichannel experience aligned with consumer media consumption. Stay connected with consumers through mobile apps, chatbots, social media, and email. Ensure that all interactions are relevant and helpful and immediately alert customers of any institutional issues or changes. The growing digital demands of consumers are influencing how people purchase banking, lending, and credit services. These changes are driving increased urgency for financial service institutions to adopt real-time financial processes that meet demands for convenience and speed. Interested in more best practices? Watch our On-Demand Webinar

Fintechs take on banks, technology, and finance as we know It. In the credit space, their reputation as a market disruptor precedes their definition. But now, as they infiltrate headlines and traditional finance as many know it – serving up consumer-centric, convenience-touting, access-for-all online marketplace lending – fintechs aren’t just becoming a mainstay within the financial spectrum’s vernacular. With their increasing foothold in the marketplace, they are here and they are gaining momentum. Since their initial entry to the marketplace in 2006, these technology-driven online platforms flaunt big data, actionable analytics and originations growing at exponential rates. Fintechs hang their hats on their ability to be the “anti-bank” of sorts. The brainchild of finance plus technology, their brands promise simple but powerful deliverables – all centered on innovation. And they market themselves as filling in the gaps commonly accepted as standard practices by traditional financial institutions. Think paperwork, less-than-instant turnaround times, a history of unwavering tradition, etc. Fintechs deliver a one-two punch, serving the marketplace as both lending companies and technology gurus – two pieces that financial institutions want and consumers crave. Now, as they grow more prominent within the marketplace, some are starting to pivot to test strategic partnerships and bring their strengths – technological infrastructure, speed and agility – to credit unions and other traditional financial institutions. According to the World FinTech Report 2018, 75.5% of fintechs surveyed want to collaborate with traditional financial services firms. The challenge, is that both fintechs and traditional financial institutions struggle with finding the right partners, efficiently working together and effectively scaling innovation. From competitors to collaborators, how can fintechs and traditional institutions strike a partnership balance? A recent report sponsored by Experian and conducted by the Filene Research Institute, explores this conundrum by examining the experiences of six financial institutions – some fintechs and some traditional FIs – as they seek to collaborate under the common goal of better serving customers. The results offer up key ingredients for fostering a successful collaboration between fintechs and traditional financial institutions – to generate real impact to the customer experience and the bottom-line. Rest assured, that in the fast-moving, disruptive world of fintech, effective partnerships such as these will continue to push boundaries and redefine the evolving financial services marketplace. Learn More About Online Marketplace Lending Download the Filene Report

Fraudsters invited into bank branches The days of sending an invitation in the mail have for the most part gone by the wayside. Aside from special invitations for weddings and milestone anniversaries, electronic and email invitations have become the norm. However, one major party planner has refused to change practices — banks inviting fraudsters into their banking centers. As a fraud consultant I have the privilege of meeting many banking professionals, and I hear the same issues and struggles over and over again. It’s clear that the rapid increase of fraudulent account-opening applications are top of mind to many. What the executives making policy don’t realize is they’re facing fraud because they’re literally inviting the fraudsters into their branches. Think I’m exaggerating? Let me explain. I often encounter bank policymakers who explain their practice of directing a suspicious person into a banking center. Yes, many banks still direct applicants who cannot be properly verified over the phone or online into their banking center to show proof of identity. Directing or inviting criminals into your bank instead of trying to keep them out is an outdated, high-risk practice — what good can possibly come of it? The argument I typically hear from non-fraud banking professionals: “The bad guys know that if they come into the bank we will have them on film.” Other arguments include that the bad guys are not typically bold enough to actually come into the banking center or that their physical security guards monitor high-traffic banking centers. But often that is where bank policies and employee training ends. Based on my years of experience dealing with banks of all sizes, from the top three global card issuers to small regional banks, let me poke a few holes in the theory that it is a good deterrent to invite perpetrators into your banking center. Let’s role-play how my conversation goes: Me: “When an underwriter with limited fraud training making the decision to direct a suspicious applicant into a banking center, what is the policy criteria to do so?” Bank policymaker: (typical response) “What do you mean?” Me: “What high-risk authentication was used by the underwriter to make the decision to extend an invitation to a high-risk applicant to come into the banking center? If the applicant failed your high-risk authentication questions and you were not able to properly identify them, what authentication tools do the branch managers have that the underwriters do not?” Bank: “Nothing, but they can usually tell when someone is nervous or seems suspicious.” Me: “Then what training do they receive to identify suspicious behaviors?” (You guessed it …) Bank: “None.” (I then switch to the importance of customer experience.) Me: “How do you notify the banking center in advance that the suspicious applicant was invited to come in to provide additional verification?” Bank: “We do not have a policy to notify the banking center in advance.” Me: “What is considered acceptable documentation? And are banking center employees trained on how to review utility statements, state ID cards, drivers’ licenses or other accepted media?“ Bank: “We do not have a list of acceptable documentation that can be used for verification; it is up to the discretion of the banking center representative.” Me: “How do you ensure the physical safety of your employees and customers when you knowingly invite fraudsters and criminals into your banking center? How do you turn down or ask the suspicious person to leave because they do not have sufficient documentation to move forward with the original application for credit? If a suspicious person provides your employee with a possible stolen identification card, is that employee expected to keep it and notify police or return it to the applicant? Are employees expected to make a photocopy of the documentation provided?” The response that I usually receive is, “I am not really sure.” I hope by now you are seeing the risk of these types of outdated practices on suspicious credit applications. The fact is that technology has allowed criminals to make fairly convincing identification at a very low cost. If employees in banking centers are not equipped, properly trained, and well-documented procedures do not exist in your fraud program — perhaps it’s time to reconsider the practice or seek the advice of industry experts. I have spent two decades trying to keep bad guys out of banks, but I can’t help but wonder — why do some still send open invitations to criminals to come visit their bank? If you are not yet ready to stop this type of bad behavior, at the very least you must develop comprehensive end-to-end policies to properly handle such events. This fraud prevention tactic to invite perpetrators into banks was adopted long before the age of real-time decisions, robust fraud scores, big data, decision analytics, knowledge-based authentication, one-time passcodes, mobile banking and biometrics. The world we bank in has changed dramatically in the past five years; customers expect more and tolerate less. If a seamless customer experience and reducing account-opening and first-party fraud are part of your strategic plan, then it is time to consider Experian fraud solutions and consulting.

By: Tom Hannagan I was hoping someone would ask about this. Return on Equity (ROE) is generally net income divided by equity, while Return on Assets (ROA) is net income divided by average assets. There you have it. The calculations are pretty easy. But, what do they mean? ROA tends to tell us how effectively an organization is taking earnings advantage of its base of assets.  This used to be the most popular way of comparing banks to each other -- and for banks to monitor their own performance from period to period. Many banks and bank executives still prefer to use ROA…though typically at the smaller banks. ROE tends to tell us how effectively an organization is taking advantage of its base of equity, or capital. This has gained in popularity for several reasons and has become the preferred measure at larger banks. One huge reason for the growing popularity of ROE is, simply, that it is not asset-dependent. ROE can be applied to any line of business or any product. You must have “assets” for ROA, since one cannot divide by zero. This flexibility allows banks with differing asset structures to be compared to each other, or even for banks to be compared to other types of businesses. The asset-independency of ROE also allows a bank to compare internal product line performance to each other. Perhaps most importantly, this permits looking at the comparative profitability of lines of business like deposit services. This would be difficult, if even possible, using ROA. If you are interested in how well a bank is managing its assets, or perhaps its overall size, ROA may be of assistance. Lately, what constitutes a good and valid portrayal of assets has come into question at several of the largest banks. Any measure is only as good as its components. Be sure you have a good measure of asset value, including credit risk adjustments. ROE on the other hand looks at how effectively a bank (or any business) is using shareholders’ equity. Many observers like ROE, since equity represents the owners’ interest in the business. Their equity investment is fully at risk compared to other sources of funds supporting the bank. Shareholders are the last in line if the going gets rough. So, equity capital tends to be the most expensive source of funds, carrying the largest risk premium of all funding options. Its deployment is critical to the success, even the survival, of the bank. Indeed, capital allocation or deployment is the most important executive decision facing the leadership of any organization. If that isn’t enough, ROE is also Warren Buffet’s favorite measure of performance. Finally, there are the risk implications of the two metrics. ROA can be risk-adjusted up to a point. The net income figure can be risk adjusted for mitigated interest rate risk and for expected credit risk that is mitigated by a loan loss provision. The big missing element in even a well risk-adjusted ROA metric is unexpected loss (UL). Unexpected loss, along with any unmitigated expected loss, is covered by capital. Further, aside from the economic capital associated with unexpected loss, there are regulatory capital requirements. This capital is left out of the ROA metric. This is true at the entity level and for any line-of-business performance measures internally. Since ROE uses shareholder equity as its divisor, and the equity is risk-based capital, the result is, more or less, automatically risk-adjusted. In addition to the risk adjustments in its numerator, net income, ROE can use an economic capital amount. The result is a risk-adjusted return on capital, or RAROC. RAROC takes ROE to a fully risk-adjusted metric that can be used at the entity level and that can also be broken down for any and all lines of business within the organization. As discussed in the last post, ROE and RAROC help a bank get to the point where they are more fully “accounting” for risk – or “unpredictable variability”. Sorry about all of the alphabet soup, but there is a natural progression that I’m pointing to that we do see banks working their way through. That progression is being led by the larger banks that need to meet more sophisticated capital reporting requirements, and is being followed by other banks as they get more interested in risk-adjusted monitoring as a performance measurement. The better bank leadership is at measuring risk-adjusted performance, using ROE or RAROC, the better leadership can become at pricing for all risk at the client relationship and product levels.