There’s an old football idiom that says, “the best defense is a great offense” This suggest winning is possible if your team just keep putting points on the board which does have some logic too it. In discussions of late with community bankers, they seem to adopt this same strategy for achieving their business goals. For purposes of this illustration, the flip side of gaining points (or revenue) for a bank could be the cost to generate that revenue-or efficiency ratio. In assessing an institutions performance, generally the lower the ratio the more efficient the institution is in growing profits. All too often in working with community bank partners, exploring improving efficiency driven by the way they operationally process services is not considered a priority (beyond a budgetary metric).
Before you say that isn’t our institution- consider that the most recently published 2022 Independent Banker Association’s CEO Survey. The top two priorities for the coming year focused on growing loans and growing earnings. The same survey reported that reducing expenses ranked 8th, a repeat ranking from the pre pandemic survey for 2020. In short, improving operational efficiency doesn’t seem to be on the minds of most of us, with or without pandemic black swan events.
So, what pushes operational reviews and focus on improved efficiency to the back burner of priorities? Through interviews and discussions, I’ve identified 3 primary causes.
First, because of lineage to the executive suit. Most CEO’s that I know rose through the ranks of customer facing roles such as commercial banking. Rarely is their prior work experience including intimate exposure with back-room support areas or technology.
Second, a natural assumption that if it ain’t broke- don’t fix it. Because of the lack of first-hand experience mentioned above, bank leaders place broad spheres of trust on Operations and Technology department executives compared with perhaps other senior roles such as Finance or Risk where healthy debate in scrutiny is more common. This lack of robust scrutiny and unfortunately siloed engagement with other departments tends to discourage change and favors doing things the way it always has been done. I even had a CEO refer to Operations once as “telephone poll climbers”- suggesting they were like linemen working or restoring power- and only noticed by most of us after a storm when we are in the dark!
Finally, there seems to be a presumption that processes are reviewed already through the bank’s existing risk management and audit framework. As routine scrutiny on these areas through regulatory safety and soundness exams or periodic audit reviews does indeed occur, rarely are operational excellence or best practice opportunities identified as outcomes. These reviews tend to focus less on efficiency and more on meeting the continued demands of regulatory rule changes, or emerging risks.
Is it possible to view efficient operations environment instead of as a cost to doing business, as a strategic imperative- proving a competitive advantage ranking as high in focus as perhaps the next LPO expansion or commercial real estate lender hire?
Efficiency in Driving Superior Results
To what extent does operational efficiency contribute to overall organization performance? As it turns out- a huge amount. Looking at FDIC call report data for the current 4,900 existing banks and looking back at their performance over the past decade, a clear difference appears in top performing and bottom performing ROE banks- and it isn’t high margins or huge growth. Overall, industry averaged just under 60% for 2021, a full 2% higher than the prior year. However, top quartile institutions enjoyed a ratio of 52%. In short, to be a top performer bank requires rigorous and deliberate understanding of your cost’s metrics and processes.
Bank’s that focus on leveraging cost to serve customers through greater operational efficiency will yield not only a competitive pricing edge in the marketplace, but a decisive roadmap and resources to build future capabilities. A ratio that is drifting higher indicates a bank is losing a greater percentage of its income to expense. I know what you’re thinking- which comes first, the efficiency or the revenue. Well let’s just leave the chicken and egg discussion aside for a minute.
Quality versus Quantity Earnings
Consider that a typical $1 billion asset community banking organization with a 70-basis point efficiency ratio, a ROA of 0.90 and an NIM of 3.30%. For every 5 bp improvement in efficiency equals an additional $2 Million in earnings to the bottom line (or equivalent to $60MM in additional earning assets). Just to move this institution to the industry average would assume a 10% increase in earning assets and improved ROA to 1.20%. With this kind of potential, why is there so little focus on improving our efficiency? It’s been my observation that generally it starts with a reluctance to dive into the way we have already done things. If it isn’t broke, don’t fix it mentality.
What should be noted however is that moving efficiency and operational excellence into an active goal for your bank will not only be valuable from an earnings perspective, but it can also be instrumental in building the kind of nimble, knowledgeable teamwork that can benefit mastery of critical disciplines- risk management, regulatory compliance, product design and delivery and servicing excellence among them.
Where to start
It’s important to note that whenever there is talk about efficiency, the idea that might first come to mind is cutting staff or finding the dead weight evaluation (think the two Bob’s from the movie Office Space). That isn’t what we’re talking about for a couple of reasons. First, your subject matter expertise within the organization (both in client and institutional knowledge) is practically irreplaceable. Second, many times it is more about freeing up capacity of people through eliminating manual or outdated process to allow faster turn around and flow– hence greater operating capacity and leverage. The resulting benefit includes improved employee and customer satisfaction through easier and more transparent processes in servicing your clients needs.
Building an Operational Excellence- 5 Keys to Success
- Culture- Regardless of the size of the institution or origins, legacy processes die hard. The organization that can get comfortable with having a framework and discipline of continuous process improvement will always have an advantage in an ever-changing marketplace. This means creating a common end to end understanding of how products and services are delivered to the customer. I recently had a client that had 4 areas of the bank that were processing ACH, wires, deposits and transfers with different policies and procedures- even though they were touching the same customers and using the same core platform system. Net result is training and maintain staff to support Online banking, Corporate Treasury management, Deposit Operations, and Loan Operations to process their own individual mis- postings, returns, originations, and risk controls.
- Strategy- Build a strategy that encompasses the entire client experience including not only day 1 but day 701. Align your strategy to include a stated required infrastructure and cost structure to compete, expected volumes of maintenance or modifications to the service or product that can be expected. This includes ensuring your training, policies, procedures, and personnel needs are considered in your customer experience. For many of my clients, I start with a simple 80/20 rule; looking at the 80% of the revenue, costs, risk, and transaction types among the client base and process map the current state. This will quickly inform what are the low handing fruit in client or associate irritants, or what makes a $4 risk have a $40 solution. Finally, make sure that you are consistently engaging your back room and support subject matter experts when planning and not as an afterthought. Simply put, superior operational delivery should be a stated strategic competitive imperative. Don’t believe me? When is the last time you bought something from Amazon? And they started with books!
- Procurement of Technology- Invest not only in technology, but the time and people it takes to fully leverage it. Business leaders should define the requirements and thoroughly understand them BEFORE selecting the technology solution- not after. Over the years I’ve come upon numerous abandoned vendor solutions where the bank is paying thousands of dollars to support a product that has 3 customers- which all 3 make a total of $40 per year to the bank. The solution might be great- and if it is, then why are there only 3 clients? If it stinks, kill it. We’ll talk more about this when we get into product management in a future writing. Suffice for now, if digital delivery architecture is a key to the institution’s success, it might be that integration is more important that features (or the other way around). Too many times I’ve come upon great technology solutions that were purchased, implemented, and then…. forgotten. They become an expense and an underutilized opportunity.
- Organizational Alignment- Build your organization around functional needs- not individuals. This is a tough one for smaller organizations where we wear many hats. The net result is that a resource that is a subject matter expert in credit administration for example, keeps that function forever- regardless of how their role evolves or organizational needs change. Start with the organization being aligned to the needs to support your strategy and THEN put people to the roles- not the other way around.
- Understand Your Metrics (and Risk)- Use data to help understand your current state and optimal performance. Example might be cross sales, number of card transactions, adoption or abandonment rates of key services like digital, channel usage, client tenure, account opening or servicing duration, or transaction frequency. Not only will these numbers highlight opportunities to save time and aggravation, they also might uncover under exploited needs or revenue resources. I once created a partnership with the 4th largest tax preparation service in America that generated millions in additional income by wondering why there was so many waived check fees at one office (that’s a story for another day).
Putting it All Together:
It’s important to keep in mind that moving to an operational excellence mindset isn’t cutting cost as it is about eliminating ancillary our outdated processes to ensure a more efficient delivery of what your institutions greatest competitive advantage. High performing institutions consider not only product and services sales and revenue growth, but also the ongoing cost of delivery support. Operational excellence starts at the top- with a through understanding of the current processes and identifying siloed or duplicated support areas and points of client or associate irritants. With a balanced strategic focus on efficiency will help inform use of scarce resources for maximum benefit, provide a competitive edge in pricing and delivery, and reinforce a continuous improvement process culture within your organization.