Bank cost management as a factor of its financial stability

Table of contents: The Kazakh-American Free University Academic Journal №6 - 2014

Author: Klimova Natalia, Moscow State University of Economics, Statistics and Informatics, Russian

Achievement of a certain economic growth by a bank, improvement of its efficiency cannot be imagined without the analysis of bank costs, cost planning, determining the most effective structure, without searching for ways to reduce bank costs. Cost management goal is to achieve the intended bank performance in the most economical way. The task of bank managers concerning cost management are always specified depending on the overall bank development objectives, the timing and scope of projected transactions, and, finally, on external factors. In this case, management process tasks are specified depending on goals, timing and scope of current or future bank costs. Thus, the objective of long-term cost planning is to prepare information on the expected costs for the development of new services, banking products, and new markets. This may be market research or capital investment costs (4, p.49). Current plans elaborate the implementation of long-term objectives of the bank. If the accuracy of long-term planning costs is low and is influenced by the inflation process, depends on the behavior of competitors, the state policy in the field of financial management, international factors, and sometimes force majeure, the short-term planning costs are more accurate, as they are reasoned by the annual and quarterly estimates.

The need for constant matching of costs and revenues, tightening of control over the costs due to lowering profitability of active operations, the low level of interest margin on interbank transactions and commercial loans determine the allocation of bank costs as an independent object of management in the bank and as an object of management accounting.

There are traditional and non-traditional approaches to determining costs as management objects (5, p. 86). According to traditional approach, stipulated by law and based on the accounting system, there are operational and non-operational, interest and non-interest expenses of the bank. This approach is necessary for the analysis of the overall economic condition of the bank and characterizes the overall level of bank management and financial management quality.

Unconventional approach, in its turn, is divided into two approaches to the allocation of costs as a management object. The first approach - "product-oriented" - involves the allocation of costs in accordance with development of various banking products and services. For example, a bank may allocate expenses for settlement services, lending, deposit and other operations.

The second approach, "customer-oriented", involves allocation of a part of the total costs for rendering services to legal bodies and individuals, interbank transactions, "development" of new markets, etc.

Both "product-oriented" and "customer-oriented" approaches, in fact, describe the costs, not only as an object of management, but also as an object of management accounting. Goals and objectives of management accounting, as it is known, are a lot broader than those of accounting. They are more adequate to the objectives of cost management as they provide bank management with all information necessary for the implementation of its development strategy. The advantage of management accounting is that it is developed based on the principles of expediency, on the rules and methods determined by each individual bank (3, p. 149):

a) bank cost calculating for each bank service and product;

b) conformity with goals and objectives of bank management;

c) feasibility and cost-effectiveness;

g) irrelevance to norms and legal requirements of overhead organizations.

Based on practical experience of Kazakh banks, we can distinguish two main levels in the bank cost management. The first level is bank cost management by the National Bank. The second level - commercial bank cost management as its traditional internal operation. The need to implement such kind of management is explained by the desire of bank managers and owners to increase the quality of the capital base, which will be used for further investments related to the expansion of the bank activity in the markets, territorial interests (opening of additional offices, branches) and ultimately for increasing profits.

On the one hand, in accordance with banking legislation, the National Bank creates for the banking system conditions of the free market, in which each bank develops independently on an equal footing with other banks. This also applies to the bank costing. In an effort to limit the risk of bankruptcy, the National Bank introduced a mechanism for the implementation of mandatory standards and the accumulation of reserves for possible losses. The first regulations governing the activities of banks, is, as we know, the capital adequacy ratio, which is designed to maintain a ratio of capital to risk weighted assets of the bank. In order to maintain a sufficient level there are options of intensive capital increase through generating profit through a policy aimed at optimization and increase in effectiveness of bank operations, and extensive options of attracting additional capital from external sources that do not require significant qualitative improvement of bank internal processes.

The introduction in 2008 of six forward liquidity ratios and forward foreign exchange liquidity ratios certainly affects bank costing in an indirect way (1). The indirect bank cost control measures include a number of requirements of the National Bank needed for reduction of credit institutions bankruptcy risk, in particular the presence of:

1) internal control services for monitoring compliance with the regulations of the National Bank, mainly related to accounting and reporting requirements;

2) bank-compliance controller in the bank staffing table, whose task is to monitor the riskiness of investments and establish mechanisms of minimizing current operation losses (this applies mainly to forward deals exposed to high risks associated with changes in external factors).

In recent years one can notice certain interest of the National Bank to the process of bank costing, which is expressed, in particular, in tightening the requirements to assessment of assets riskiness and creation of provisions (2). It’s a reasonable measure, but not sufficient enough. As long as there is methodological and regulatory vacuum in the practice of cost management, banks are forced to exercise self-development, building on existing experience and knowledge. And it's not so much the desire of bank management to achieve a high degree of detailed elaboration and accuracy in cost accounting but rather the ability to optimize bank costs while ensuring quality and profitability of products and services offered by the bank.

Organization of cost management involves not only cost allocation as a control object, but also the definition of the subjects of cost management. Managers and bank department specialist act as subjects of cost control.

Thus, the process of cost management is a system that consists of two subsystems: managing - management subject and managed - management object, which is completely in line with the overall management system (5, p.70).

Adequate cost management goals are to achieve the intended performance of the bank in the most economical way and they can be defined as important challenges faced by the bank cost management:

a) providing a qualitative analysis of the bank costs, which will allow a better assessment of the efficiency of the resources allocation, identification of costs reduction reserves, obtaining information for the development of plans and rational cost management decisions;

b) coordination and regulation of costs (planning) involve comparing actual costs with the planned costs, rapid detection of deviations and, as a result, taking prompt measures to eliminate them. Timely cost coordination and regulation allows the bank to avoid a serious disruption in the implementation of planned operations and reduction in overall bank performance;

c) creation of a cost accounting management system, which is essential for preparing information for the bank management in order to make the right decisions to reduce or optimize current and future bank costs;

d) organization of control (monitoring) system of cost management provides feedback, comparison of planned and actual costs. The effectiveness of control stems from corrective management actions aimed at bringing the actual costs in line with planned costs or plan updates if the latter cannot be implemented due to the objective change in conditions;

d) adoption of the most efficient ways and methods to optimize costs;

e) development of techniques of bank costs management.

Solving these management tasks is possible only in the bank cost management process.

The process of bank cost management consists of two components:

1) cost management at the stage of making investment decisions concerning bank establishment and subsequent development;

2) management of current costs at the stage of its operation.

It is known that investment decisions are decisions on current expenditure carried out in order to generate revenue in the future. Of course, all bank expenditures are carried out in order to gain profit in the future, however, current costs of the operating bank and investments at the stage of bank creation and development differ considerably, especially in terms of payback. Short-term solutions concerning current expenses are taken for a relatively short period of time - up to one year, which spans from investment of funds to obtaining profit. Decisions concerning capital investments are intended for a longer period - from bank investment to making profit. Investments of this kind include interest costs that must be considered when making an investment decision in the banking business. With short-term investments interest on invested capital is so small that, in practice, it is usually neglected.

It should be noted that of all the decisions made by the owners and management of the bank, investment decisions are the most difficult, because the process of involving significant financial resources is often irreversible. In this regard, the owners of the bank should have clearly defined investment objectives, such as profit maximization, maximizing the growth of the bank, ensuring its competitiveness, achieving the desired level of profit or obtaining the highest possible market share. In this case, the owners of the bank should be aware that investments in risky projects may turn into partial losses or into a significant loss of capital.

When making investment decisions (investments in the building, banking equipment, software, advertising, etc.), banks make an analysis of volumes of investments and investments payback periods.

Management of current costs can be performed through budgeting.

Economic literature and modern bank management practitioners actively discuss various models of the organization of the bank budgeting process as a "closed loop of organizational and managerial activities aimed at designing and implementing control over the major budget items in order to improve the manageability and reliability of a commercial bank."

Budgeting is of particular interest, since its introduction into bank management keeps bank costing and revenue generation up to date. At the same time paying tribute to development of the theory of bank budgeting, we should note that during the implementation of the budgeting model cost management is generally considered in the context of transfer pricing - the price of funds transfer between departments of the bank. In this case, the goal of transfer pricing is "revealing the value of risk-adjusted net interest income for each business unit, product or customer." The analysis of budgeting model offered in the economic literature proves that bank costs in terms of selection and subsequent implementation of these models are presented in the most general form, which allows a greater degree of effectiveness in establishing the transfer price, but does not tell much about the best possible way of bank costing and about the organization of the effective cost management process.

In this regard, the budgeting model, focused on the set of the responsibility centers determined with consideration of the nature of their activity, is of a greater interest. This model of budgeting is in line with "product-oriented" and "client-oriented" approaches to determining costs as management and accounting management objects (5, p.98).

In economic theory, there is a dual definition of responsibility centers as structural units (a combination of units) offering homogeneous products and services, or as management units with specific objectives, budgets and reporting requirements. In our opinion, the second definition reflects the purpose and objectives of cost management more accurately.

Bank units are assigned to certain responsibility centers with consideration of the following:

a) information flows between bank structural units;

b) products and services produced and consumed by bank structural units;

c) cash flows passing through the bank structural units;

g) relationships with other units;

d) consumers of products and services produced by the bank structural units.

An example of cost distribution by structural units of the commercial bank is presented in Table 1.

At the same time banks develop a hierarchical system of linear and functional relationships between managers and professionals involved in cost management, which must be compatible with the organizational structure of the bank.

The table shows that the distribution of the costs among the respective centers truly reflects the economic nature of the activities of units, but does not explain the process of bank costing and cost management. It should be emphasized once again that in the banking practice and theory there is no single distinct model of bank cost management, although some elements of this process are mandatory and long-proven in the overall bank management process, the analysis of bank costs, the estimation of current and future costs, cost estimation planning, control and execution in particular.

Table 1. Cost distribution by bank centers

It should be noted that banks usually develop documents that regulate processes associated with the procedure of development, approval and control over the estimation of costs, mainly describing the budgeting process, but not revealing bank cost management mechanisms as a whole. Methodological processes, practical recommendations and conclusions discussed in this article can be used by Kazakhstan commercial bank managers, whose goal is to effectively manage costs within the framework strategy aimed at developing a sustainable competitive advantage.


1. Resolution of the Board of FIA "On approval of the Instruction on standard values and methods of calculation of prudential standards for second-tier banks" dated September 30, 2006 № 358, as amended

2. Resolution of the Board of FIA “On Approval of Rules for the classification of assets, contingent liabilities and creation of provisions (reserves) against them” dated December 25, 2008 № 296, as amended and augmented.

3. Mirzhakypova S.T. Bank Accounting in the Republic of Kazakhstan: a textbook. Part 1 - Almaty, 2011, 784 p.

4. Petrov A.Y. Comprehensive Analysis of the Bank Financial Performance. M.: Financy i statistika, 2010, 560 p.

5. Sheremet A.D. Financial Analysis in Commercial banks. - Moscow, 2011.

Table of contents: The Kazakh-American Free University Academic Journal №6 - 2014

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