Management of Financial Institutions
This article focuses on the management of financial institutions. It provides an overview of the main management strategies used in financial institutions, including activity-based costing, asset-liability management, profitability analysis, risk management, technology and information management, crisis management, and issues management. The management issues associated with federal and state regulation of financial institutions are addressed.
Keywords Activity-Based Costing; Asset-Liability Management; Credit Unions; Crisis Management; Financial Institutions; Financial Services; Information Management; Issues Management; Knowledge Management System; Management; Organization; Organizational Crisis; Profitability Analysis; Risk Management; Thrifts
Finance: Management of Financial Institutions
Financial institutions, which move money throughout society in both complex and simple financial transactions, include banks, credit unions, thrifts, savings associations, trust companies, offices of foreign banks, and issuers of travelers checks and money orders. The success and strength of financial institutions depends in large part on their effective management. Management refers to the work or act of directing and controlling a group of people within an organization for the purpose of accomplishing shared goals or objectives. Classic management, as defined by Henri Fayol and Frederick Taylor, consists of five main functions, roles, or actions: Planning, organizing, leading, coordinating, and controlling. Management theory, practice, and scholarship are characterized by a focus on issues of leadership, group dynamics, and employee motivation.
Managers in financial institutions must respond to new technologies, new organizational models, the economic forces of globalization, and increased diversity in the workforce. Modern financial institutions, responding to new technology, increased competition, and changes in trade regulations around the world, are transitioning from hierarchical and centralized forms to group-model and decentralized organizations. In response to the new forms of business organizations, such as large-scale financial institutions, high-tech companies and multinational corporations, management has evolved its skill set to include greater facility for managing change, information, and human differences.
Financial institutions face unique management concerns and challenges due to the degree of government regulation within the financial industry. The management of financial institutions is a complex process involving management sectors of accounting, investment, human resources, and risk assessment. Common management practices used in financial institutions include account-balance costing, asset-liability management, profitability analysis, information management, crisis management, issues management, technology and information management, and risk management. The management of financial institutions has changed significantly since the 1970s. Changes in the following areas have affected management practices in financial institutions: Regulation and deregulation, product diversification, and industry convergence (Kafafian, 2001).
- Regulation and deregulation: The financial industry has undergone significant periods of regulation and deregulation since the 1970s when interest rate limits and geographic quota restrictions were ended. The government regulatory agencies vie for control over regulatory issues such as consumer privacy, merchant banking, community reinvestment, and consumer disclosure.
- Product diversification: The diversification of financial products, particularly traditional banking products, began in the 1970s as a result of regulatory changes. The Gramm-Leach-Bliley Financial Modernization Act, passed in 1999, increased the financial products and services available to consumers in the areas of brokerage, trust, money management, insurance, credit cards, and securitization. The Gramm-Leach-Bliley Financial Modernization Act replaced earlier laws that had prohibited financial institutions from engaging in insurance and investment activities. The Gramm-Leach-Bliley Financial Modernization Act resulted in the creation of numerous commercial and full service banking and financial service institutions. Financial institutions are currently working to adapt the products and services they offer to the needs of their customers. Internet banking has expanded the products and services that financial institutions offer and consumers expect.
- Industry convergence: Financial institutions, such as banks, brokerage firms, money managers, insurance companies, insurance agencies, and data processing vendors, are consolidating their business domains. For example, there are fewer banks in operation than there were in the 1970s. The financial industry is in flux as once discrete businesses attempt to combine operations, product offerings, markets, customers, and internal employee cultures.
In the United States, and developed nations in general, financial institutions facilitate economic growth through lending, savings, and commerce. The early history of formal financial institutions in the United States established the pattern of connection between the health of financial institutions and the economy at large. In the 18th century, banks, life insurance companies, and trading companies were established in the United States. These financial institutions facilitated large-scale economic growth in the United States manufacturing industry, infrastructure, home ownership, business development, international trade, and market formation. Due to the importance of financial institutions for the economic and social health of the nation as a whole, the government actively regulates financial institutions. Clearly, the management practices of financial institutions, as well as the products and services offered by financial services, are scrupulously monitored and regulated by the government. The successful management of financial institutions has a significant impact and influence on the nation.
The following section provides an overview of the main management strategies used in financial institutions including activity-based costing, asset-liability management, profitability analysis, risk management, technology and information management, crisis management, and issues management. This section will serve as the foundation for later discussion of the ways in which management of federal institutions is influenced by state and federal regulations.
Management Strategies in Financial Institutions
Management of financial institutions is a multifaceted endeavor involving the oversight and direction of human resources, accounting, investment, resource-allocation, production, research and design, and finance areas. Common management practices used in financial institutions include activity-based costing, asset-liability management, profitability analysis, risk management, technology and information management, crisis management, and issues management.
Activity-based costing is an accounting or finance-based management tool used in management accounting. Managers use activity based accounting to identify, describe, assign costs to, and report on operations. Activity-based costing is used in three main ways: a tool to aid strategic decision-making; a lens into the decision-making process; and a resource allocation mechanism. Activity-based costing facilitates strategic decision-making and cost reduction. It allows management to make decisions from an informed and objective basis (Rafiq & Garg, 2002).
Asset-liability management refers to a risk management practice used to make investment or disinvestment decisions and maintain the credit service ratio. The asset-liability management process generates graphical analysis, data analysis, and interest rate simulation for use in the budget making process. Asset liability management includes the important area of gap analysis. Gap analysis, a tool for comparing actual and potential performance, helps managers answer the following questions: Where are the fundamental mismatches of cash flows and maturities on the balance sheet? Does the institution have a positive or negative gap between actual and potential performance? What is the effect of interest rate changes on the profitability, viability, and safety and soundness of the corporation? Federal regulators require financial institutions to create and distribute a formal asset-liability management report for investors.
Profitability analysis, often part of a larger project of cost-volume profitability analysis, is an analytical tool which compares the inner workings and profitability of a financial institution....
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