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PEARLS//AboutPEARLS

April25,2016

WhatisPEARLS?
Protection
EffectiveFinancialStructure
AssetQuality
RatesofReturnandCosts
Liquidity
SignsofGrowth
PEARLSisafinancialperformancemonitoringsystemdesignedtooffermanagementguidanceforcreditunions
andothersavingsinstitutions.PEARLSisalsoasupervisorytoolforregulators.PEARLScanbeusedtocompareand
rankinstitutionsandcanprovidecomparisonsamongpeerinstitutionsinonecountryoracrosscountries.
PEARLSisasetoffinancialratiosorindicatorsthathelpstandardizeterminologybetweeninstitutions.Intotal,there
are44quantitativefinancialindicatorsthatfacilitateanintegralanalysisofthefinancialconditionofanyfinancial
institution.Thepurposeforincludingamyriadofindicatorsistoillustratehowchangeinoneratiohasramificationsfor
numerousotherindicators.
Eachindicatorhasaprudentialnormorassociatedgoal.Thetargetgoal,orstandardofexcellenceforeachindicatoris
putforthbyWorldCouncilofCreditUnionsbasedonitsfieldexperiencewithstrengtheningandmodernizingcredit
unionsandpromotingsavingsbasedgrowth.Depositorscanhaveconfidencethatsavingsinstitutionsthatmeetthe
standardsofexcellencearesafeandsound.
PEARLS,primarilyamanagementtoolforinstitutions,canalsobeusedasasupervisorytoolbyregulators.Asa
managementtool,PEARLSsignalsproblemstomanagersbeforetheproblemsbecomedetrimental.Forboardsof
directors,PEARLSprovidesatooltomonitormanagement'sprogresstowardfinancialgoals.Forregulators,PEARLS
offersindicatorsandstandardstosupervisetheperformanceofsavingsinstitutions.
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WhousesPEARLS?
Inpartnershipwithcreditunions,WorldCouncilcreatedPEARLSinthelate1980s.WorldCouncilhasrefinedand
adjustedPEARLSoverthepastdecades.WorldCouncilusesPEARLSwithallcreditunionsparticipatinginitstechnical
assistanceprogramsaroundtheworld.Inadditiontoindividualcreditunionsandcreditunionnationalfederationsand
associations(includingmanyWorldCouncilmembers),theBolivianSuperintendencyofBanksusesPEARLSto
superviseregulatedcreditunionsinBolivia.

WhatdoesPEARLSmonitor?
rotection
Theprimarygoalofevaluatingtheprotectionindicators,astheheadingimplies,istoensurethatthefinancialinstitution
providesdepositorsasafeplacetosavetheirmoney.Provisionsforloanlossesarethefirstlineofdefenseagainst
unexpectedlossestotheinstitution.Allowancesforloanlossesareessential,sincedelinquencysignalsthatloansare
atriskthus,theinstitutionmustsetasideearningstocoverthosepossiblelossessothatmemberclientsavingsremain
protected.
Whenfinancialintermediariesdonotrecognizeloanlosses:
Assetvaluesareinflated
Reportednetincomeisoverstated
Provisionsforloanslossesarelacking
Memberclientsavingsarenotsecure
Dividendsareoverstatedanderroneouslypaidout
ThemostcriticalratiounderprotectionisP1.ThegoalofP1istohave100%provisionsforloanlossesfromloansthat
aregreaterthan12monthsdelinquent.Accuratemeasurementofdelinquency(totaloutstandingbalanceofportfolioat
riskat30days),indicatorA1,isintegrallylinkedtothecreationofadequateallowancesforloanlosses.
Theprotectionsectionconsidersloanwriteoffsonaquarterlybasisforloansdelinquentmorethan12months.The
practiceofwritingoffloansisimportantbecauseafteraloanisdelinquentforoneyear,itisunlikelytheinstitutionwill
receiverepaymentofthatloan.Theinstitutionusestheprovisionsithassetasideof100%ofthevalueofthatloantowrite

offthedelinquentloan.Asaresultofthewriteoff,thebalancesheetwillaccuratelystatethevalueoftheinstitution's
assets.
Towriteoffaloandoesnotmeantheinstitutionstopsseekingtocollectpaymentontheloan.Forthisreason,protection
indicatorsalsoconsideramountsrecoveredfromwrittenoffloans.
Thelastindicatorundertheprotectionheadingissolvency.Thisindicatormeasurestherelativeworthofonedollarin
memberclientsavingsafteradjustingforknownandprobablelosses.
Theformulaforcalculatingthisratiois:
[(TotalAssets+TotalAllowances)(100%ofLoansDelinquent>12Months+35%ofLoansDelinquentfrom1
12Months+TotalLiabilities+ProblemAssets)Deposits]/TotalSharesandTotalDeposits
PProtection

Goals(Excellence)

1.LoanLossesAllowances/Delinq.>12Mo.

100%

2.NetLoanLossAllowances/WorldCouncilAllowanceRequiredforDelinq.
112Mo.

35%

3.CompleteLoanChargeoffofDelinq.>12Mo.

Yes

4.AnnualLoanChargeoffs/AverageLoanPortfolio

Minimized

5.Accum.ChargeoffsRecovered/Accum.Chargeoffs

>75%

6.Solvency(NetValueofAssets/TotalShares&Deposits)

111%

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ffectiveFinancialStructure
Thefinancialstructureisthemostimportantvariablethataffectsgrowth,profitabilityandefficiency.Creditunions
thatmaintainmost(7080%)oftheirtotalassetsintheloanportfoliohavethegreatestopportunitytomaximizereturnson
theseproductiveassetswhileprovidingtheirmemberclientswiththecreditservicestheyseek.Similarly,institutionsthat
fundtheirassetsprimarily(7080%)withmemberclientdepositsareindependentfromthefluctuatingpriceofexternal
funds.
Financialstructureisalwayschangingandrequirescarefulmanagement,especiallyincasesofrapidgrowth.
TheeffectivefinancialstructureareaofPEARLSfocusesonaninstitution'ssourcesoffunds(savings,shares,external
creditandinstitutionalcapital)anditsusesoffunds(loans,liquidinvestments,financialinvestmentsandnonearning
assets).ThePEARLSsystemprovidesinformationovertimetherefore,managers,directorsandregulatorscanobserve
thestructuralevolutionofboththesourcesoffundsandtheusesoffunds.
Aninstitutionhasaneffectivefinancialstructurewhenassets,financedbysavingsdeposits,generatesufficient
incometopaymarketratesonsavings,coveroperatingcostsandmaintaincapitaladequacy.
Institutionalcapital,alllegalreservesandsurpluscreatedeitherfromtheaccumulationofnetincomeorfromcapital
donations,isthesecondlineofdefensetoabsorbunexpectedlosses.Institutionalcapitalcanbeinvestedtoexpand
productsandservices.Italsocanbeusedtopayforthehighcostsoftechnologyandbuildingconstruction.
NetInstitutionalCapital,ratioE9,isReserves,RetainedEarningandProvisionsnetof100%ofdelinquentloansgreater
than12monthsandnetof35%ofdelinquentloansbetween30364daysoverduedividedbyTotalAssets.
EEffectiveFinancialStructure
1.NetLoans/TotalAssets

Goals(Excellence)
7080%

2.LiquidInvestments/TotalAssets

16%

3.FinancialInvestments/TotalAssets

2%

4.NonfinancialInvestments/TotalAssets
5.SavingsDeposits/TotalAssets
6.ExternalCredit/TotalAssets

0%
7080%
05%

7.MemberShareCapital/TotalAssets

20%

8.InstitutionalCapital/TotalAssets

10%

9.NetInstitutionalCapital/TotalAssets

10%

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ssetQuality
AssetQualityisthemainvariablethataffectsinstitutionalprofitability.Anexcessofdefaultedordelayedrepayment
ofloansandhighpercentagesofothernonearningassetshavenegativeeffectsoncreditunionearningsbecausethese
assetsarenotearningincome.AsmentionedintheProtectiondiscussion,itisessentialthatdelinquencybemeasured
correctlyandminimized.Delinquency,commonlyreferredtoasportfolioatrisk,isthetotaloutstandingbalanceofloans
delinquentgreaterthan30days.Thisratioisameasurementofinstitutionalweaknessbecauseifdelinquencyishigh,
thenotherkeyareasofcreditunionoperationscouldbeweake.g.loanlossprovisions,institutionalcapitalandnet
income.
Inadditiontocontrollingdelinquency,institutionsalsomustmonitortheratioofnonearningassetstototalassetsand
ensurethatthesenonearningassetsarenotfinancedbysavingsdeposits,externalcreditormembershares(inthecase
ofacreditunionorotheruserownedfinancialcooperative).Sourcesoffundsthathaveafinancialcostsuchassavings
depositsneedtobeinvestedinproductiveassetsthatwillearnareturngreaterthanthecostoffunds.Theonlywayto
havenonearningassets,suchasfixedassets,withoutnegativelyaffectingearningsistofinancethoseassetswithno
costcapitalsuchasinstitutionalcapitalorreserves.
AAssetQuality

Goals(Excellence)

1.TotalLoanDelinquency/GrossLoanPortfolio

5%

2.NonearningAssets/TotalAssets

5%

3.NetZeroCostFunds/NonearningAssets

200%

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atesofReturnandCosts
TheRatesofReturnandCostsindicatorsmonitorthereturnearnedoneachtypeofasset(useoffunds)andthecostof
eachtypeofliability(sourceoffunds).Ontheassetsside,onecandeterminewhattypesofassetsearnthehighest
returns.Ontheliabilityside,onecandeterminewhataretheleastandmostexpensivesourcesoffunds.
Yieldsandcostsdirectlyaffectthegrowthratesofaninstitution.Theintentisforaninstitutionto:payrealratesof
returnonsavingsandshares,chargeratesonloansthatrecoverallcostsandpaycompetitivesalariesforemployees.
ThegoalofR1,NetLoanIncomedividedbytheAverageNetLoanPortfolio,isforloanpricestobesetat
entrepreneurialrates.Theentrepreneurialrateneedstocoverthecostoffunds,thecostofoperationsand
administration,thecostofprovisionsandthecostofcontributionstoincreasecapital.
Theincomeratiosidentifyincomefromnetloans,liquidassets,financialinvestmentsandnonfinancialinvestments.
Financialcostratioslookatthecostsofsavingsdeposits,externalcreditanddividendsonshares.Operatingcostratios
(R9,R10)separateoutoperatingcostsandprovisionsforriskassets.
RRatesofReturnandCosts

Goals(Excellence)

1.NetLoanIncome/AverageNetLoanPortfolio

EntrepreneurialRate

2.LiquidInv.Income/Avg.LiquidInvestments

MarketRates

3.Fin.InvestmentIncome/Avg.Fin.Investments

MarketRates

4.Nonfin.Inv.Income/Avg.Nonfin.Investments

R1

5.Fin.Costs:SavingsDeposits/Avg.SavingsDeposits

MarketRates>Inflation

6.Fin.Costs:ExternalCredit/Avg.ExternalCredit
7.Fin.Costs:MemberShares/Avg.MemberShares
8.GrossMargin/AverageAssets
9.OperatingExpenses/AverageAssets

MarketRates
MarketRates,>R5
E9=10%
5%

10.ProvisionsforRiskAssets/AverageAssets

P1=100%,P2=35%

11.OtherIncomeorExpense/AverageAssets

Minimized

12.NetIncome/AverageAssets(ROA)

E9=10%

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iquidity
Managingliquidityisanessentialcomponentofadministeringasavingsinstitution.
ThegoalofL1,15%ofshortterminvestmentsminusliquidassetsminusshorttermpayablesovertotalsavingsdeposits,
servestomaintainshortterminvestmentliquiditytorespondtomemberclientwithdrawalanddisbursementdemands.
ThegoalofindicatorL3,tomaintaintheratioofcostlynonearningliquidassetstolessthan1%oftotalassets,isto
minimizenonearningcashtomostdailyopeationalneeds.
LLiquidity

Goals(Excellence)

1.LiquidAssetsSTPayables/TotalDeposits

1520%

2.LiquidityReserves/TotalSavingsDeposits

10%

3.NonearningLiquidAssets/TotalAssets

<1%

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ignsofGrowth
SignsofGrowthreflectmemberclientsatisfaction,appropriatenessofproductofferingsandfinancialstrength.
Growthdirectlyaffectsaninstitution'sfinancialstructureandrequiresclosemonitoringtomaintainbalanceforexample,
growthinsavings(S5)drivesgrowthintotalassets(S11),butifloans(S1)arenotgrowingasquicklyassavings,thenthe
institutionwillhavehighliquidity(L1)andlowearnings(R12).Similarly,assavingsaregrowing,itisimportanttowatch
thatinstitutionalcapital(S8)isincreasingatasimilarpacesothattherewillbeabuffertoprotectthosesavingsagainst
unexpectedlosses.ThegrowthindicatorsofPEARLScanhelpmanagersmaintainabalancedandeffectivefinancial
structure.
GrowthinTotalAssetsisacriticalindicatorsince16oftheotherPEARLSperformanceindicatorsarelinkedtoit.
Aninstitutionneedstomaintainaccuratemacroeconomicinformation,particularlytheannualizedinflationrate,inorderto
attainpositiverealgrowth.
SSignsofGrowth(AnnualizedRates)
1.NetLoans

Goals(Excellence)
E1=7080%

2.LiquidInvestments

E216%

3.FinancialInvestments

E32%

4.NonfinancialInvestments

E4=0%

5.SavingsDeposits

E5=7080%

6.ExternalCredit

E6=05%

7.MemberShares

E720%

8.InstitutionalCapital

E810%

9.NetInstitutionalCapital

E910%

10.Membership

15%

11.TotalAssets

>Inflation+10%

HowdoPEARLS&CAMELdiffer?
TherearethreeprimarydifferencesbetweenthePEARLSandtheCAMEL(CapitalAdequacy,AssetQuality,
Management,Earnings,Liquidity)monitoringsystems:
PEARLSusesstrictlyquantitativeindicatorswhileCAMELusesquantitativeandqualitative(e.g.,Management).
PEARLSprovidesanobjectiveevaluationoffinancialperformancebyreviewingtheresultsofthestrictly
quantitativeindicators.
PEARLSevaluatesthefinancialstructureofthebalancesheet.Financialstructurehasadirecteffectonthe
efficiencyandprofitabilityofafinancialinstitutionsincethemoreaninstitutionmaximizesproductiveassets,the
morepossibilitiesithastogenerateearnings.
PEARLSmeasuresgrowthrates.Monitoringgrowthindifferentareasnotonlyallowsinstitutionstoassessthe
degreeofsatisfactionamongmemberclients,butalsoassistsmanagerstomaintainaneffectivefinancial
structuregiventhatgrowthdirectlyaffectsfinancialstructure.
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2016WorldCouncilofCreditUnions,Inc