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Initially, WOCCU staff tried to adapt the US CAMEL ranking system to the
credit unions in Guatemala, but found that several modifications were
needed. CAMEL is a supervisory tool; in the US, its ratios intend to protect
the solvency of institutions and the safety of member deposits. Beyond
supervision, WOCCU was looking for a tool that would evaluate the financial
structure of the balance sheet, critical to Guatemalan credit unions
undergoing a major restructuring of assets, liabilities and capital. In
addition, credit union mangers needed to monitor growth of total assets,
seen as key to addressing the problems resulting from monetary devaluations
and runaway inflation. In essence, PEARLS was designed first as a management
tool, and later became an effective supervisory mechanism.
Drawing on the results of using PEARLS in Guatemala, WOCCU adopted a new
approach to credit union development in 1994. In the new model credit union,
market pricing for products and services facilitates local savings
mobilisation. With PEARLS, WOCCU has set international financial standards
for credit union performance. Key ratios within the PEARLS are summarised
below.
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Protection is measured by comparing the adequacy of the provisions for loan
losses against the amount of delinquent loans. The Protection category also
includes loan charge-offs and loan recovery rates.
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The financial structure of the credit union is the most important factor in
determining growth potential, earnings capacity, and overall financial
strength. Ratios in this category measure assets, liabilities and capital,
and their associated targets constitute an ideal structure for credit
unions. Two ratios are of note here: The capital ratio that measures the
relationship of capital to assets should govern the institution's growth -
when its gets too low, management should change its pricing to slow growth
and protect its reserves. In the saving-led credit union movement, where
demand for loans should be met through savings mobilisation, fuelling growth
with borrowed capital is discouraged, hence a target of zero percent for
borrowed capital to asset ratio in Table 1 Minimum Standards (see below).
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The indicators in this section measure the impact of assets which do not
generate income such as delinquent loans, and non-productive assets
(Traditionally, credit unions have used member share capital to finance
fixed assets. Under the new model, the goal is to finance a 100 percent of
all non-productive assets with the credit union's institutional capital, or
with other liabilities that have no explicit financial cost.)
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Unlike other systems, which calculate yields on the basis of average assets,
PEARLS calculates yields on the basis of actual investments outstanding. The
PEARLS system also disaggregates the essential components of net earnings
(distinguishing return on the loan portfolio, liquid investments, financial
and non-financial investments) to help management calculate investment
yields and evaluate operating expenses. The results more clearly indicate
whether the credit union is earning and paying market rates on its assets,
liabilities, and capital.
The "R" category also measures operational costs including financial costs
paid on deposit savings, share-savings, and external loans. The target
recommended by the PEARLS system is to maintain operating expenses between 3
to 10 percent of average total assets.
PEARLS separates the costs of creating provisions for loan losses from other
administrative costs. By isolating this expense from the other
administrative costs, one gets a clearer picture of the effect of weak
credit administration on a credit union.
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The liquidity indicators reveal if the credit union is administering its
cash to meet deposit withdrawal requests and liquidity reserve requirements
while, at the same time, minimising the amount of idle funds. The "ideal"
target is to maintain a minimum of 20 percent of deposit savings in liquid
accounts, after paying all immediate obligations under 30-days. The idle
liquid funds ratio should be as close to zero percent as possible.
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In this section of PEARLS, the indicators measure both financial and
membership growth. Total assets growth is one of the most important ratios.
By comparing the growth in total assets to other key areas, it is possible
to detect changes in the balance sheet structure, which could have a
positive or negative impact on earnings. If loan growth keeps pace with
growth in total assets, there is a likelihood that profitability will be
maintained. Because savings deposits are the cornerstone of credit union
growth, savings deposit growth largely governs the change in total assets.
Because share growth is de-emphasised in the model credit union, excessive
growth rates in this area usually signal a credit union's failure to promote
deposits over shares. Institutional capital growth is the best indicator of
profitability within the credit union. Sustained growth of institutional
capital that exceeds the growth of total assets is a strong indicator of
credit union success.
Table 1 below shows key ratios and target goals that WOCCU has selected as
the minimum standards for measuring credit union performance. To date, Latin
American credit unions come closest to meeting these targets.
Indicator
|
Standard
(Target or Goal)
|
Protection
|
Loan loss provision for loans delinquent > 12
months/Outstanding balance of these loans |
100% |
Loan loss provision for loans delinquent < 12
months/Outstanding balance of these loans |
Minimum of 35% of delinquent loans from 2 to 12 months |
Effective Financial Structure
|
Assets: Net loans/Total assets |
60 to 80% (country specific) |
Liquid investments/Total assets |
Maximum = 20% |
Fixed (unproductive) assets/Total assets |
Maximum = 5% |
Liabilities: Savings & deposits (excluding
shares)/Total assets Country specific target |
70 to 80% |
External borrowing/Total assets |
Minimised with a goal toward 0% |
Capital: Reserves & retained earnings/Total assets |
Minimum of 8% of total
assets |
Share Mix: Withdrawable shares/Total assets |
Country specific |
Asset Quality
|
Outstanding balance of delinquent loans > 30
days/Total loans (*) |
Goal is <
or = 5%;
Maximum 10% of outstanding loans |
Non-earning assets/Total assets (*) |
Maximum of 7% |
Rates of Return & Costs
|
Operating expenses/Average assets (*) |
< or = 10% |
Net income/Average assets |
Sufficient to maintain capital ratio of > 8% |
Return to members on share |
> inflation rate |
Liquidity
|
Liquidity Reserve/Withdrawable savings & deposits |
10% minimum |
Signs of Growth
|
Annual net change in total assets/Total assets of
previous year |
Country
specific > or = population growth rate |
Annual net change in loans/Total loans of previous
year |
Country specific >
or = inflation rate |
Annual net change in withdrawable shares, savings and
deposits/Total savings and deposits |
Country specific > or = inflation rate |