PEARLS rating system


Objective: PEARLS uses a set of financial ratios to monitor the financial stability of the credit unions within WOCCU's developing movement projects. These ratios provide credit unions, project staff, national federations and regulators with essential tools for monitoring, planning, standardizing, ranking and facilitating supervisory control in credit unions.

Methodology: Each letter in the word PEARLS measures the key areas of credit union operations: Protection, Effective financial structure, Asset quality, Rates of return and costs, and Liquidity and Signs of growth.

P = Protection. Protection is measured by comparing the adequacy of the provisions for loan losses against the amount of delinquent loans. A credit union has adequate protection if it has sufficient provisions to cover 100% of all delinquent loans for more than 12 months and at least 35% of loans delinquent between 1 and 12 months.

E = Effective Financial Structure. Financial structure of the credit union is the single most important factor in determining growth potential, earnings capacity and overall financial strength. The PEARLS system measures credit union assets, liabilities and capital, then recommends the "ideal" structure. Credit unions are encouraged to maximize earning assets as the means to achieve sufficient earnings.

A = Asset Quality. A non-earning asset is one that does not generate income. An excess of non-earning assets negatively affects credit union income. PEARLS indicators are used to identify the impact of non-earning assets by analyzing delinquency ratios, percentages of non-earning assets and the financing of non-earning assets.

R = Rates of Return and Costs. By segregating all of the essential components of net earnings, the PEARLS system helps management calculate investment yields and evaluate financial costs and operating expenses. PEARLS calculates yields on the basis of average outstanding investments, unlike other systems that calculate yields on the basis of average assets.

Yield is computed in four main areas: loan portfolio, liquid investments, financial investments and other non-financial investments. Operating costs are also important and broken down into three main areas: financial intermediation costs, administrative costs and unrecoverable loan costs. "By segregating in-come and expenses into the previously mentioned areas, PEARLS ratios can accurately pinpoint the reasons why a credit union is not producing sufficient net income," noted Dave Richardson, WOCCU Director of Technical Development.

L = Liquidity. Liquidity is traditionally viewed in terms of cash available to lend - a variable exclusively controlled by the credit union. With the introduction of withdrawable savings deposits, the concept of liquidity radically changes. Richardson explained, "Liquidity now refers to cash needed for withdrawals - a variable the credit union can no longer control. The maintenance of adequate liquidity reserves is essential to sound, financial management of the new credit union model." PEARLS analyzes liquidity from three perspectives: total net liquidity reserves, obligatory liquidity reserves and idle liquid funds.

S = Signs of Growth. The advantage of the PEARLS system is that it links growth to profitability, as well as to other key areas by evaluating the strength of the system as a whole. Growth is measured in seven key areas: total assets, loans, savings deposits, external credit, shares, institutional capital and membership.

Hari Srinivas -
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