Page 250 - DMGT514_MANAGEMENT_CONTROL_SYSTEMS

Unit 13: Management Control of Service Organisation

they pay on these deposits corresponds approximately to cost of sales in a manufacturing Notes
company. Thus, net interest expense, income, which is the difference between interest revenue
and interest, is a key number for bank management to watch, it corresponds to gross margin in
a manufacturing company. If the difference between interest revenue and interest expense plus
revenue from other activities, more than covers its operating costs and loan loses, the bank is
profitable.

Did u know? Commercial banks are regulated by the Central Bank Authority.

13.5.2 Management Control Implications

Interest Rates: The relationship between interest revenue and interest expense is a key variable.
Banks regularly calculate the amount of interest sensitive assets, interest sensitive liabilities and
the ‘gap’ which is the difference between them, is the bank’s interest rate exposure; both prudent
management and rules of regulatory bodies require that it be kept within certain bounds.
Banks refer to the elements of risk as ‘four Cs’, the borrower’s general character, its capability to
repay the loan from earnings or other sources, its capital on net assets, and the collateral pledged
for the specific loan. For accepting greater risks, the bank expects a greater reward. Senior
management has the task of setting the rates on loans of various risks and maturities, of setting
corresponding ratio for deposits and of assuring that the actions of the individual managers add
up to a satisfactory interest rate exposure for the bank as a whole.

!
Caution The management control system must ensure that its rates are communicated
throughout the organisation and that they are adhered to.
Volume: Most expenses are fixed in the short-term. Therefore, if a bank can increase its volume
of deposits, other things being equal, it will be able to make more loans and the increased gross
margin (i.e. net interest income) will increase its profits.
Loan losses: The central bank including the government has imposed strict limits for
“non-performing loans” (i.e. loans whose payments are delinquent). These prevent the banks
from making additional loans.
Expenses: Most of the expenses in a bank are personal related and are subject to budgeting and
controls that are similar to the controls in a manufacturing company.
Other income: Banks earn income by handling trust accounts, collecting receivables and
performing various other services for customers. Such services should be rendered at cost plus
a profit margin.
Joint revenues: A depositor whose account is maintained in one branch may do business at
another branch. Branch managers want to receive credit for the revenues that they generate by
such activities and to be compensated for services that they furnish to customers of other branches.
If the bank is organized into profit centres, the allocation of joint revenues can have a significant
impact on profits.

Profit Centres: Many commercial banks set up profit centres, for their branches or for their
individual headquarters activities, or both. In that case, transfer price for money should be
solved. This price is an expense (similar to cost of sales) to activities that make loans and
investments and it is revenue to activities that generate deposits. Some branches are ‘loan
heavy’ (i.e. their loans exceed their deposits) and others are ‘deposit heavy’, profitability will

LOVELY PROFESSIONAL UNIVERSITY 245