Low interest rates have not only stabilized the banking industry, but have resulted in windfall profits from extraordinary spreads.

Banks should be using these profits to finance the basic restructuring required to compete effectively in the next five years.

Nonbank competitors such as GE Capital, General Motors Corp., Ford Motor Co., and American Telephone and Telegraph Co. ar "cherry-picking" high-margin consumer businesses. Meanwhile, banks are becoming obsolete in commercial lending.

Banks must take the low-rate opportunity to put their houses in order.

Huge Profit Impact

The rate environment has created extraordinary net interest margins. The Federal Deposit Insurance Corp. has recently been reporting average spread of 30 to 40 basis points larger than historical norms.

Roughly one-third of the industry's 1992 pretax earnings was attributable to these spreads.

The windfall profits have enabled the industry to stabilize. Though it may not be completely out of the woods, it is well into a turnaround.

Yet the banking industry is missing an attractive opportunity to prepare for the intense competition of the next five years. Most banks are not using these windfall profits to fund the one-time charges for a basic restructuring of their economics

Window of Opportunity

Why is restructuring necessary?

Today's spreads cannot last forever. Congress may not enact the spending side of the President;s equation; economic growth may exceed expectations, thereby fueling inflation; and over time, loan pricing will adjust downward.

Lower spreads would again exert pressure on bank profitability,, primarily because banks' operating costs are too high and their prices are too low. The average efficiency ratio (costs to revenues) for publicly traded banks has remained at about 65% since the mid-1980s.

However, top-quartile banks are operating with efficiency ratios in the range of 50% to 55%.

What is the potential of an industry restructuring?

On the cost side, most banks -- even on a stand-alone basis, without acquisition - can reduce their noninterest expenses by between 20% and 30% without degradation of service or basic changes in strategy.

Reductions of such magnitude do not come easily. They result from a fundamental reengineering of every process, procedure, and work flow in the institution. That means looking in minute detail at the way things are done.

This reengineering, when combined with a "delayering" of the organizational hierarchy -- moving senior managers closer to the customers - can actually enhance customer service.

Moreover, banks have systematically underpriced their products and services.

When products and services are broken down and the perceived value of transactions to different classes of customers analyzed in detail, banks can increase their noninterest revenue 15% to 20% with little or no account run-off.

Customers simply value banks' services more than bankers think.

These may sound like outlandish numbers, given the failure to banks to realize such impact even following an acquisition (where savings in the range of 40% to 50% are achievable).

However, given the will and skill to make fundamental change, restructuring can more than double earnings over 12 to 18 months. The stock market rewards such change handsomely.

Take, for instance, three restructuring programs in which I have been involved:

* Chase Lincoln First Bank, Rochester, N.Y.: Improvements worth $50 million pretax were identified, raising return on assets by 44 basis points and return on equity by 600 basis points.

* Midlantic Corp. Edison, N.J.: $100 million in savings -- 25% of noninterest expenses -- have been derived from more than 2,000 employee-generated ideas to improve efficiency. The market rewarded the bank with a 400% increase in the stock price last year, adding $740 million in shareholder value.

* Star Banc Corp., Cincinnati: The efficiency ratio is projected to improve to 55% from 62% - at an institution that generated a 1.1% ROA and a 14% ROE even before restructuring. Since August of last year, the bank's stock price has risen 30%, adding $275 million in shareholder value.

The commitment of the windfall spread earnings to fund one-time charges associated with such restructuring is essential to meeting the intense competition of the next five years.

The industry cannot afford to be complacent. Extraordinary spreads are not sustainable over the intermediate term.

Mr. Allen is chairman of Aston Limited Partners, a bank investment and operations restructuring firm based in New York.

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