A minute for your Feedback please

Saturday, April 16, 2011

The importance of activity based costing in financial markets

Any student of management accounting/cost accounting would have studied the classic examples of how enterprises undercost/overcost their products/services, often without even knowing it. If this is the case with tangible products with relatively well known costs, imagine the situation with intangible & complex financial products. For them, the main cost is the cost of funds. That can be determined in a variety of ways
  1. Funding rate for that tenor('duration') in the open marlet
  2. Existing cost of funds for the bank(as a whole)
  3. Existing cost of funds for the bank(in that maturity bracket)
But this cost does not factor in the other strategic & tactical costs like keeping funds ready, alignment with bank objectives etc. For that reason, a subjective preagreed adjustment is often made via a spread to compensate for risks like illiquidness, refinancing etc.But factoring in the exact amount of this adjustment, is an exercise very close to calculating cost drivers in routine activity based costing. So given all this, one should not forget to price the products appropriately, which in turn needs a strong grasp of risk and liquidity. Else as Jamie Dimon(CEO, Bank of America) put it in his inaugural shareholders letter (Many companies
design products that lose money, and they do not even know it.).
So for their grasp over the cost flow, management accountants and structurers are well equipped to advice on these aspects. In banks, the department which fixes the main funding cost(ALM-Asset and Liability Management) often uses these two skillsets in plenty.

No comments: