ECONOMIC PROFIT AND PERFORMANCE-MEASUREMENT IN BANKING

Successful bank operation requires managers to weigh complex trade-off s between growth, return, and risk. In recent years banks increasingly have adopted innovative performance metrics based on the concept of e conomic profit, rather than accounting earnings, to assist managers in making such difficult and complex decisions. Banks hope in this way t o elicit better decision-making by managers and also to align manageri al behavior more closely with the interests of shareholders. This arti cle analyzes the use of economic profit for measuring the performance of banks, focusing on the allocation of equity capital to products, cu stomers, and businesses. The author reviews the use of economic profit to evaluate performance, to price transactions, and to reward manager s. He describes in detail one performance measurement and incentive sy stem and then goes on to discuss the shortcomings of performance metri cs founded on economic profit, which may distort banks' investment and operating decision-making. He concludes that banks need to recognize the ambiguities of such calculations and be prepared to create and app ly multiple specialized performance measures.