What Drives the Performance of Financial Institutions

Abstract

The financial sector is one of the most, if not the most significant economic sector in modern societies. In advanced countries, it employs more people than major manufacturing industries combined and accounts for a high percentage of the Gross Domestic Product. But the financial services sector also plays a large indirect role in national economies. The financial sector mobilizes savings and allocates credit across space and time, and enables firms and households to cope with uncertainties by hedging, pooling, sharing and pricing risks. This ultimately improves the quantity and quality of real investments and increases income per capita and raises standards of living. Today financial institutions are experiencing unprecedented change in a competitive global environment. Economies of scale that lead to more integrated automation lead to further economies of scope. Technological innovation adds competitive pressures, and provides opportunities for new non-traditional providers. Consumers themselves may be the strongest force of change in the financial services industry since their needs are evolving quickly. Banking institutions are being transformed from financial intermediaries to retail service providers - they now formulate products for clients or intermediaries, sell and service a range of products to customers and also provide the support functions needed for the successful execution of its primary activities. The authors ask how they can measure performance of a financial institution in this changing landscape? Traditional productivity measures are difficult to compute and tell us less than they used to. The authors also seek to identify what drives performance and identify three dimensions of performance drivers to explore: strategy; execution of strategy; and the environment. To begin, the authors define performance to mean economic performance as measured by financial indicators. Quality of services and effective risk management help explain strong performance levels. Strategic decisions that affect an institution's success involve product mix, client mix, geographical location, and distribution channels. In terms of strategy execution, the authors cite x-efficiency, human resource management, use of technology, process design, and the successful alignment of all these components as important factors in successful firm performance. Creating the right technology environment also has a significant impact on performance. The remainder of this paper summarizes the fifteen chapters of a book edited by the authors on performance and its drivers. The book is divided into three section: General; Drivers of Performance; and Environmental Drivers of Performance. There are also two chapters at the end that discuss performance and risk management. The authors then briefly discuss possible future research directions, including the relationship between operational efficiency and quality of services, the balance between risk management and retail services in bank activities, and study of interorganizational issues.

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