How Banks Can Get A 45% Efficiency Ratio - Part II

Improving Bank Efficiency

In our previous post (HERE), we discussed the importance of driving bank efficiency to below 45% over the next five years. Many banks have already saved between 5% to 10% of total expenses by cutting waste and renegotiating contracts. Taking another look at your core, online and mobile contracts alone can probably save you that much not to mention taking another look at your purchasing. After that, you need to be strategic. In Part I of this article we covered the first two ways to reduced cost. In this post, we present four other items that can bring your bank to under a 45% efficiency ratio and help you achieve superior performance.


Digitize Processes: Banks have woefully inefficient processes. We know, because we recently have started going through several and have found we can dramatically reduce customer time and our own labor cost dramatically. For example, moving our small business loans online has cut total origination hours spent by almost 60%, freed up more than 80% of our relationship manager’s time and reduced direct costs by almost 70%. If you can restructure your business loans, your retail loans, your account opening and your conflict resolution process, it is likely your bank can save another 10% on their cost structure.  


Underwriting Costs


Scale Revenue: Asset growth without gaining scale can hurt franchise value. Make sure your growth increases your efficiency otherwise you could be hurting, not helping, your bank’s value if you are producing under your cost of capital. To gain scale, banks need to think about redefining the definition of “community” and start to serve a wider audience. The old rule of thumb was that a branch could serve a ten-mile radius. With the popularity of mobile/online banking, remote safes, remote deposit capture, lockbox and other digital banking products, there is now no limit. If you serve law firms in your city, why not serve law firms in your state? Make it a long-term strategic initiative to expand your banking platform to reach well beyond your immediate branch service area, and you can potentially dramatically improve scale and improve your efficiency ratio.


Change Customer Mix: Some customers are more profitable than other customers. That is just a fact of banking. Medical groups, insurance companies, non-profits, trade associations, hospitality companies, law firms and hundreds of other industries have a risk and cost adjusted profitability ratio of about a 20% return on equity. Why not offer these customers better pricing and spend more on marketing in order to bank more of these customer types?


Bank Customer Segment Profitability


Change Product Mix: Just as different customer types don’t have the same profitability, different bank products don’t have the same profitability. Why not develop and promote products with higher returns? For example, not all deposit products are equal (below). Become the bank in your state that specializes in youth sports, homeowners associations or medical accounts and watch your returns grow while your efficiency improves.


Deposit Product Profitability


Putting This Into Action


Making efficiency improvement a formal strategy, executing branch transition, digitize various processes, and improving both your customer and product mix can easily drop efficiency below 45%. There are approximately 300 banks in our industry that consistently produce below a 45% efficiency ratio. It is no surprise that this same cohort of high-efficiency banks averages about a 20% ROE. In fact, it is very hard to be a consistently top performing bank without focusing on efficiency.


As more banks improve efficiency and employ ever-increasing amounts of technology, the performance gap will further increase. High efficiency can take place at almost any asset size, so it is important to note that bigger isn’t always better. What matters is operating leverage. Banks that focus on gaining operating scale as opposed to just growing assets will come out ahead. While part of the answer is technology, most of the answer is just having the strategic desire to effect change.