What is PEARLS?
PEARLS is a financial performance monitoring system designed to
offer management guidance for credit unions and other savings
institutions. PEARLS is also a supervisory tool for regulators.
PEARLS can be used to compare and rank institutions and can provide
comparisons among peer institutions in one country or across countries.
PEARLS is a set of financial ratios or indicators that help standardize terminology between institutions.
In total, there are 44 quantitative financial indicators that
facilitate an integral analysis of the financial condition of any
financial institution. The purpose for including a myriad of indicators
is to illustrate how change in one ratio has ramifications for numerous
Each indicator has a prudential norm or associated goal. The target
goal, or standard of excellence for each indicator is put forth by World
Council of Credit Unions based on its field experience with
strengthening and modernizing credit unions and promoting savings-based
growth. Depositors can have confidence that savings institutions that
meet the standards of excellence are safe and sound.
PEARLS, primarily a management tool for institutions, can also be used
as a supervisory tool by regulators. As a management tool, PEARLS
signals problems to managers before the problems become detrimental. For
boards of directors, PEARLS provides a tool to monitor management's
progress toward financial goals. For regulators, PEARLS offers
indicators and standards to supervise the performance of savings
Who uses PEARLS?
In partnership with credit unions, World Council created PEARLS in the
late 1980s. World Council has refined and adjusted PEARLS over the past
decades. World Council uses PEARLS with all credit unions participating
in its technical assistance programs around the world. In addition to
individual credit unions and credit union national federations and
associations (including many World Council members), the Bolivian
Superintendency of Banks uses PEARLS to supervise regulated credit
unions in Bolivia.
What does PEARLS monitor?
The primary goal of evaluating the protection indicators, as the heading
implies, is to ensure that the financial institution provides
depositors a safe place to save their money. Provisions for loan losses are the first line of defense against unexpected losses to the institution. Allowances
for loan losses are essential, since delinquency signals that loans are
at risk; thus, the institution must set aside earnings to cover those
possible losses so that member-client savings remain protected.
When financial intermediaries do not recognize loan losses:
- Asset values are inflated
- Reported net income is overstated
- Provisions for loans losses are lacking
- Member-client savings are not secure
- Dividends are overstated and erroneously paid out
The most critical ratio under protection is P1. The goal of P1 is to have 100% provisions for loan losses from loans that are greater than 12 months delinquent. Accurate
measurement of delinquency (total outstanding balance of
portfolio-at-risk at 30 days), indicator A1, is integrally linked to the
creation of adequate allowances for loan losses.
The protection section considers loan write-offs on a quarterly basis
for loans delinquent more than 12 months. The practice of writing off
loans is important because after a loan is delinquent for one year, it
is unlikely the institution will receive repayment of that loan. The
institution uses the provisions it has set aside of 100% of the value of
that loan to write off the delinquent loan. As a result of the
write-off, the balance sheet will accurately state the value of the
To write off a loan does not mean the institution stops seeking to
collect payment on the loan. For this reason, protection indicators also
consider amounts recovered from written-off loans.
The last indicator under the protection heading is solvency. This
indicator measures the relative worth of one dollar in member-client
savings after adjusting for known and probable losses.
The formula for calculating this ratio is:
[(Total Assets + Total Allowances) - (100% of Loans Delinquent > 12 Months + 35% of Loans Delinquent from 1–12 Months + Total Liabilities + Problem Assets) - Deposits] / Total Shares and Total Deposits
|P - Protection
|1. Loan Losses Allowances / Delinq. >12 Mo.
|2. Net Loan Loss Allowances / World Council Allowance Required for Delinq. 1-12 Mo.
|3. Complete Loan Charge-off of Delinq. > 12 Mo.
|4. Annual Loan Charge-offs / Average Loan Portfolio
|5. Accum. Charge-offs Recovered / Accum. Charge-offs
|6. Solvency (Net Value of Assets/Total Shares & Deposits)
ffective Financial Structure
The financial structure is the most important variable that affects growth, profitability and efficiency. Credit
unions that maintain most (70–80%) of their total assets in the loan
portfolio have the greatest opportunity to maximize returns on these
productive assets while providing their member-clients with the credit
services they seek. Similarly, institutions that fund their assets
primarily (70–80%) with member-client deposits are independent from the
fluctuating price of external funds.
Financial structure is always changing and requires careful management, especially in cases of rapid growth.
The effective financial structure area of PEARLS focuses on an
institution's sources of funds (savings, shares, external credit and
institutional capital) and its uses of funds (loans, liquid investments,
financial investments and non-earning assets). The PEARLS system
provides information over time; therefore, managers, directors and
regulators can observe the structural evolution of both the sources of
funds and the uses of funds.
An institution has an effective financial structure when assets,
financed by savings deposits, generate sufficient income to pay market
rates on savings, cover operating costs and maintain capital adequacy.
Institutional capital, all legal reserves and surplus created either
from the accumulation of net income or from capital donations, is the
second line of defense to absorb unexpected losses. Institutional
capital can be invested to expand products and services. It also can be
used to pay for the high costs of technology and building construction.
Net Institutional Capital, ratio E9, is Reserves, Retained Earning and
Provisions net of 100% of delinquent loans greater than 12 months and
net of 35% of delinquent loans between 30–364 days overdue divided by
|E - Effective Financial Structure
|1. Net Loans / Total Assets
|2. Liquid Investments / Total Assets
|3. Financial Investments / Total Assets
|4. Non-financial Investments / Total Assets
|5. Savings Deposits / Total Assets
|6. External Credit / Total Assets
|7. Member Share Capital / Total Assets
|8. Institutional Capital / Total Assets
|9. Net Institutional Capital / Total Assets
Asset Quality is the main variable that affects institutional profitability.
An excess of defaulted or delayed repayment of loans and high
percentages of other non-earning assets have negative effects on credit
union earnings because these assets are not earning income. As mentioned
in the Protection discussion, it is essential that delinquency be
measured correctly and minimized. Delinquency, commonly referred to as
portfolio-at-risk, is the total outstanding balance of loans delinquent
greater than 30 days. This ratio is a measurement of institutional
weakness because if delinquency is high, then other key areas of credit
union operations could be weak; e.g. loan loss provisions, institutional
capital and net income.
In addition to controlling delinquency, institutions also must monitor
the ratio of non-earning assets to total assets and ensure that these
non-earning assets are not financed by savings deposits, external credit
or member shares (in the case of a credit union or other user-owned
financial cooperative). Sources of funds that have a financial cost such
as savings deposits need to be invested in productive assets that will
earn a return greater than the cost of funds. The only way to have
non-earning assets, such as fixed assets, without negatively affecting
earnings is to finance those assets with no-cost capital such as
institutional capital or reserves.
|A - Asset Quality
|1. Total Loan Delinquency / Gross Loan Portfolio
|2. Non-earning Assets / Total Assets
|3. Net Zero Cost Funds / Non-earning Assets
ates of Return and Costs
The Rates of Return and Costs indicators monitor the return earned on
each type of asset (use of funds) and the cost of each type of liability
(source of funds). On the assets side, one can determine what types of
assets earn the highest returns. On the liability side, one can
determine what are the least and most expensive sources of funds.
Yields and costs directly affect the growth rates of an institution. The
intent is for an institution to: pay real rates of return on savings
and shares, charge rates on loans that recover all costs and pay
competitive salaries for employees.
The goal of R1, Net Loan Income divided by the Average Net Loan
Portfolio, is for loan prices to be set at Òentrepreneurial rates.Ó The
entrepreneurial rate needs to cover the cost of funds, the cost of
operations and administration, the cost of provisions and the cost of
contributions to increase capital.
The income ratios identify income from net loans, liquid assets,
financial investments and non-financial investments. Financial cost
ratios look at the costs of savings deposits, external credit and
dividends on shares. Operating cost ratios (R9, R10) separate out
operating costs and provisions for risk assets.
|R - Rates of Return and Costs
|1. Net Loan Income / Average Net Loan Portfolio
|2. Liquid Inv. Income / Avg. Liquid Investments
|3. Fin. Investment Income / Avg. Fin. Investments
|4. Non-fin. Inv. Income / Avg. Non-fin. Investments
|5. Fin. Costs: Savings Deposits / Avg. Savings Deposits
||Market Rates > Inflation
|6. Fin. Costs: External Credit / Avg. External Credit
|7. Fin. Costs: Member Shares / Avg. Member Shares
||Market Rates, > R5
|8. Gross Margin / Average Assets
|9. Operating Expenses / Average Assets
|10. Provisions for Risk Assets / Average Assets
|11. Other Income or Expense / Average Assets
|12. Net Income / Average Assets (ROA)
Managing liquidity is an essential component of administering a savings institution.
The goal of L1, 15% of short-term investments minus liquid assets minus
short-term payables over total savings deposits, serves to maintain
short-term investment liquidity to respond to member-client withdrawal
and disbursement demands. The goal of indicator L3, to maintain the
ratio of costly non-earning liquid assets to less than 1% of total
assets, is to minimize non-earning cash to most daily opeational needs.
|L - Liquidity
|1. Liquid Assets - ST Payables / Total Deposits
|2. Liquidity Reserves / Total Savings Deposits
|3. Non-earning Liquid Assets / Total Assets
igns of Growth
Signs of Growth reflect member-client satisfaction, appropriateness of product offerings and financial strength. Growth
directly affects an institution's financial structure and requires
close monitoring to maintain balance; for example, growth in savings
(S5) drives growth in total assets (S11), but if loans (S1) are not
growing as quickly as savings, then the institution will have high
liquidity (L1) and low earnings (R12). Similarly, as savings are
growing, it is important to watch that institutional capital (S8) is
increasing at a similar pace so that there will be a buffer to protect
those savings against unexpected losses. The growth indicators of PEARLS
can help managers maintain a balanced and effective financial
Growth in Total Assets is a critical indicator since 16 of the other PEARLS performance indicators are linked to it.
An institution needs to maintain accurate macroeconomic information,
particularly the annualized inflation rate, in order to attain positive
|S - Signs of Growth (Annualized Rates)
|1. Net Loans
|2. Liquid Investments
||ˆE2 ≤ 16%
|3. Financial Investments
||ˆE3 ≤ 2%
|4. Non-financial Investments
|5. Savings Deposits
|6. External Credit
|7. Member Shares
||ˆE7 ≤ 20%
|8. Institutional Capital
||ˆE8 ≥ 10%
|9. Net Institutional Capital
||ˆE9 ≥ 10%
|11. Total Assets
||> Inflation + 10%
How do PEARLS & CAMEL differ?
There are three primary differences between the PEARLS and the CAMEL
(Capital Adequacy, Asset Quality, Management, Earnings, Liquidity)
- PEARLS uses strictly quantitative indicators while CAMEL uses
quantitative and qualitative; (e.g., Management). PEARLS provides an
objective evaluation of financial performance by reviewing the results
of the strictly quantitative indicators.
- PEARLS evaluates the financial structure of the balance sheet.
Financial structure has a direct effect on the efficiency and
profitability of a financial institution since the more an institution
maximizes productive assets, the more possibilities it has to generate
- PEARLS measures growth rates. Monitoring growth in different areas
not only allows institutions to assess the degree of satisfaction among
member-clients, but also assists managers to maintain an effective
financial structure given that growth directly affects financial