Balancing risk and revenue: cost of quality within the banking industry

By developing a better understanding of costs associated with improving organizational quality and costs incurred by neglecting it, banks could devise more optimal operational policies. The paper aims to discuss this issue.

This paper proposes a generic banking cost of quality (COQ) model developed from Colombian banking data. The model has been developed using the product performance approach, which is consistent with strategizing from a long-term and organization-wide perspective. The proposed COQ function is composed of prevention and appraisal categories, costs caused by events of operational risks and opportunity costs caused by events of credit risks measured though non-performing loans.

The model was validated using data obtained from three major Colombian banks. The significant theoretical contribution of this research stems from the development of a banking COQ model which represents a pioneer effort at quantifying quality costs in financial institutions.

This is a unique attempt at using a product performance approach in service industry and also a rare effort toward incorporating opportunity costs in COQ. Managerially, the proposed COQ model can be established as a holistic business strategy and can serve as a tool helping managers to evaluate the impact of quality management initiatives and to decide on trade-offs between quality level and quality costs.