Three government researchers claim to have found the secret to making banks more efficient.
Writing in the current issue of the journal Perspectives, the researchers said that banks, in order to succeed, need involved shareholders and managers who own a stake in the company.
Shareholders prevent banks from taking unwarranted risks or spending money foolishly because they don't want to lose their investment, said Richard J. Sullivan, an economist at the Federal Reserve Bank of Kansas City and one of the study's authors.
The finding counters a growing view that shareholder involvement on boards of directors is unnecessary, he said. "We have found the quality of boards of directors can make a difference," Mr. Sullivan said. "Boards are not irrelevant."
Managers who hold an ownership interest also are more vigilant, the researchers said. As a result, they contain costs better than those without a stake in the company.
The most efficient banks tied a manager's salary to the bank's performance, Mr. Sullivan said. They also paid their managers more, he said.
The study was written by Mr. Sullivan and Kenneth Spong of the Kansas City Fed, and Robert DeYoung of the Office of the Comptroller of the Currency.
The researchers looked at 143 banks with an average $48 million in assets in the seven-state region covered by the Kansas City Fed. The 73 most efficient banks averaged a 1.47% return on average assets, more than twice what the least efficient banks earned.
Mr. Sullivan said the results are applicable to large banks because the management structure at many of the banks that were studied mirrors that in use at regional banks.
The researchers found efficient banks spent heavily on risk management, allowing them to avoid some of the economic potholes other banks fell into. They also found efficient banks have higher-than-average loan-to-asset requirements, and hold more capital. Efficient banks also earned profits from interest income, were active lenders, and had more transaction accounts.
Inefficient banks shared several characteristics, the researchers reported. The biggest drag was the management structure. The researchers said these banks often were led by professional managers who did not own stock in their companies. These banks typically also had a large number of shareholders, most of whom didn't take an active interest in running the bank.
Finally, they said inefficient banks earned more money from fees and held more securities than efficient institutions.
There is hope for inefficient banks, the researchers said. All the banks studied paid about the same rates on deposits and had nearly identical loan losses. So, an inefficient bank could improve by changing its management structure, the study concluded.