Current Capital Budgeting Procedures in Commercial Banks

Article excerpt

The banking industry has experienced many changes in the last several years, and there are no indications the future will be different. One of the most significant drivers of the future change is likely to be the Riegle-Neal Interstate Banking and Branching Efficiency Ad of 1994, which will allow banks to open branches nationwide starting in 1997. Analysts who track bank acquisitions predict a major upsurge in merger and acquisition activity, especially in small to medium size banks. Some experts predict that the number d banks by the year 2000 will be approximately half the current 10,000.(1)

This movement of banks and bank holding companies into new markets and the concomitant capital expenditures will increase the potential for using a variety of capital budgeting techniques. In an effort to gauge current industry practices for capital budgeting and to serve as a basis for measuring change, a survey of commercial banks was undertaken. This paper presents the findings of that survey.

THE SURVEY

A survey instrument was mailed to the chief financial officers of 490 commercial banks. The banks were chosen at random from the banks listed in the 1993 Moody's Bank and Finance Manual. The respondents were not asked to identify themselves or their institution.

The questionnaire asked about bank characteristics, such as total assets and deposits, and capital budgeting procedures. Fifty-five surveys were returned, a rate of approximately 11%. This response rate is low; however, it has become increasingly difficult to entice financial executives to respond to mail surveys from finance and accounting professors.(2) In addition, there were no follow-up mailings to banks that did not return the first mailing.

The survey was designed to gather information both about bank characteristics and about capital budgeting procedures. Bank characteristics were examined from a number of perspectives, including size, control, and state in which the bank operated. Questions about capital budgeting procedures included not only tool preference, but also risk acknowledgment, project review, and annual capital expenditure.

ANALYSIS OF RESPONSES

Bank Characteristics. The first questions on the survey were designed to determine the characteristics of the responding banks. We inquired about total assets, capital assets, deposits, the number of banking locations, and the state in which the bank conducted business. Responding banks conduct business in 33 different states. The characteristics of the banks that responded are summarized in Table 1 at the end of this article. (Table 1 omitted) In order to estimate any response bias, we collected this same data from Moody's on the sample. There is no significant difference between the distribution of the responses and the distribution of the sample, leading us to assume that the banks that responded were representative of the industry as a whole.

Additional questions were asked about the control of the surveyed banks. 77% of the respondents indicated that the bank was controlled by a holding company. Again, there appears to be no significant difference between respondents and survey sample for this question. Of the controlled banks, a large majority, 74%, do not have a capital budgeting process determined by the controlling organization.

Capital Budgeting Procedures. The results of the survey indicate that almost all the responding banks are involved in spending at least some funds for capital assets each year. Only four banks indicated that they either made no capital expenditures, or else did not disclose information about their annual capital budgets.

Just over 25% (14) of the responding banks do not use any capital budgeting techniques for evaluating capital expenditure decisions. The annual capital expenditures for these firms range from $25,000 to $30,000,000, with all but five banks spending less the $1,000,000 annually. the average annual capital budgets for firms using some form of capital budgeting procedure range from $5,000 to $30,000,000. …