Managing Bank Capital: Capital Allocation and Performance Measurement, 2nd Edition

5

Capital Allocation versus Capital Investment

This chapter examines in detail some fundamental questions: How do banks invest their capital? And how do they measure the return on that investment? It is one of the contentions of this book that the management of many banks have often failed to appreciate the subtlety of these questions. At the very least, it has caused considerable confusion between the finance staff and those responsible for pricing loans and other transactions. At the root of the problem lies a confusion between the allocation of capital to particular businesses, and the investment of capital as a cash resource.

This confusion is natural enough when we consider the backward state of management information systems (MIS) in most banks. It is ironic that an industry which prides itself on its state-of-the-art technology and highly qualified staff should have such a poor basis for understanding its businesses. In part, this is due to the rapid pace of change in the banking environment over the past two decades—any industry would have had difficulty keeping its MIS up-to-date during such a period of tumultuous change. In part, it is due to the nature of the products which a bank produces: whereas in most industries the input and output of goods and services are measured in terms of money, in a bank it is money itself which forms much of the input and output. Finally, it is partly due to the fact that, during the headlong rush into new activities, most of the technology ...