Forecasting Methods for Banks
This article will focus on Forecasting Methods for Banks.
Have you done this? – According to Nasdaq, the consensus Earnings per Share (EPS) forecast for Bank of America for the years 2017, 2018, and 2019 is $1.73, $2.03, and $2.19 respectively. How did they come up with these numbers? If I told you that an analyst for Nasdaq went to the corner fortune teller and asked them to divine the numbers, you would laugh at me. Or if I told you that they called three different gas stations for their price of gas for their research, you would say that the information was irrelevant.
According to Gary Giroux’s doctoral thesis entitled “Financial Forecasting in Commercial Banks – an Industry Survey,” the AICPA defines financial forecasting as:
… an estimate of the most probable financial position, results of operations, and changes in financial position for one or more future periods…based on management’s judgment of the most likely set of conditions and most likely course of action. [Accounting Standards Executive Committee (1975), Para. 06]
Probably the most import piece of this definition is the most likely course of action taken by management. A forecast is not a passive event. It is the result of management’s plan of attack that will result financial outcomes. Believe me, Bank of America has a laundry list of action items in order for them to achieve their EPS forecast.
Are there Forecasting Methods for Banks that I can use? – Doctoral theses and AICPA definitions sound so complicated. According to Organisation for Economic Co-operation and Development (OECD) there are a few simple but sound forecasting methods for banks and other institutions that can be utilized for best results. Let’s review some of them:
Assessing the current situation – This involves the use of Corporate Performance Management (CPM) and Key Performance Indictor’s (KPI’s) of your bank. Such measures and keys might be net interest margin, revenues per FTE, customer satisfaction surveys, and your customer cross-sell ratio. Where are they in comparison to their goals, peers, last year’s numbers, and more?
The use of indicator models – If you are in the business of making home loans, how are home sales tracking in you market? What is the Federal Reserve saying about the future of interest rates? If they go up, how will your bank react? If the local manufacturing plant decides to close, what impact will that have on your nonperforming loans? You forecast needs to take into account external factors and events that will impact your bank’s performance.
Key variables and relationships – If you plan to increase your loan and deposit production, you will need to spend some money on marketing efforts. Will that be in the form of selling incentives to your employees, direct marketing dollars on radio advertising, acquiring a predictive analytics tool to figure what product to offer what customer at what time? If I pay my employees more, will you attract better talent that can service and sell to your customers? There are key levers that if pulled will result in better outcomes.
Lie Dharma Putra, CPA wrote an excellent article on Qualitative Forecasting Methods and Techniques that can be utilized by banks. He came up with four methods that will achieve great results for your company.
Executive Opinions – Who better to ask about the future of the company’s results than the company’s management. They are in tune with the strategic plan of the bank and have lots of input on how to get there. Marketing will have input on ways to get the word out about your latest financial instruments. Your Asset Liability Manager will have a pulse on where interest rates are going and how you will need to price loans and deposits. Your Human Resources Manager will know about the most effective incentive programs.
Delphi Method – This is a group technique in which management is questioned individually about their perceptions of future events. They do not meet as a group, in order to reduce the possibility that consensus is reached because of dominant personality factors. Instead, the forecasts and accompanying arguments are summarized by an outside party and returned to the team along with further questions. This continues until a consensus is reached.
Sales Force Polling – I worked at a bank where the CEO and CFO came up with the EPS target agreed to by the Wall Street analysts of the bank and was then tasked to dole out the plan for the four hundred branches to implement. We did this a couple of times and the branch network never took ownership. Then one year I was asked to have the branch network come up with their own plan with some general guidance. What the salesforce of the bank came up with was more aggressive than what the street was asking for in our EPS. Using your salespeople who have continual contacts with customers for the forecast will yield great results. Salespeople are closest to the ultimate customers will have significant insights regarding the state of the future market.
Consumer Surveys – Some companies conduct their own market surveys regarding specific consumer purchases. Surveys may consist of telephone contacts, personal interviews, or questionnaires as a means of obtaining data. Extensive statistical analysis usually is applied to survey results in order to test hypotheses regarding consumer behavior. You may find out that if you raised your fee on a certain activity that eighty percent of your customers will leave you.
Too much information! Where do I start? As you can see, there is tons of data that goes into a good forecast for a bank. If you are just getting into financial forecasting for your bank, you might want to consider Oracle Hyperion Financial Management, SAP Business Planning & Consolidation, IBM – Cognos TM1, and Solver’s BI360. These tools will collect data that comes mainly from your general ledger, and then they provide customizable forecast input forms as well as workflow to manage the forecast process.
When you are ready to get started with the non-financial pieces of your forecast such as customer, internal process, and growth and learning measures, you are going to need a data warehouse with a decent reporting engine. The list of good solutions are IBM Cognos, SAP BusinessObjects, Oracle Business Intelligence Enterprise Edition, and again BI360 by Solver.
Whether you are just getting started on your forecasting journey for your bank or are well into rolling forecasts, BI360 by Solver is a tool that will grow with your bank and its data needs as the solution is very scalable. Solver, Inc. is happy to answer any questions and generally review BI360’s easy-to-use, Excel-powered reporting and forecasting solution for banking and finance industry users. Stop relying fortune tellers for your EPS projections and utilize good forecasting methods for banks today