Over the last two years banking has enjoyed record profits - yet there was no letup in the media coverage and analyses saying banks are endangered, facing reduced profits, shrinking relevance, and possibly even demise.

According to my research, many of these concerns are well founded. Bankers may be missing a golden opportunity to use today's profits as a platform for long-term prosperity.

To do that, bankers first need to understand that more than 100% of the industry's profit improvement of the last two years came from reductions in loan-loss provisions.

To be sure, noninterest revenues rose, but their rise was more than offset by a drop in net interest margin and an increase in noninterest expense.

The latter trends are ominous, particularly because loan-loss provisions are at or below historical levels, and because industry experts foresee an increase in credit problems over the next several years. The stock market has already recognized this trend by according banking companies an average price-earnings ratio of about 10, well below the market average of 15.

Underlying these financial performance facts are some fundamental issues relating to the business of banking, and addressing these issues is bankers' true management challenge.

I believe they have four imperatives: regaining lost market share, differentiating the institution, increasing efficiency, and managing risk.

On and off the balance sheet, banks have been losing market share for years. Though most bankers recognize the problem, many seem to have little idea how to deal with it.

Given that fact, I looked at the kinds of firms that have been taking market share away from the banks - companies like Schwab, IDS, Fidelity, and Merrill Lynch.

They differ from the typical bank in four fundamental ways:

*Their employees are, on average, more expert. Call any of these firms and ask about one of their products, and you will most likely get a more expert answer than if you do the same with a bank.

The typical securities or financial planning firm hires a different kind of employee than a bank does, but more important, it compensates these people differently. Training levels, processes, and corporate culture are other contributors to the differences in employee expertise.

*They make better use of customer information. Banks generate a tremendous amount of financial information about their customers but throw most of it away. The nonbank firms hold on to it.

But retention of information is only part of the equation. Market share winners are constantly looking for matchups between customers and products, and customer information is critical to finding those matches.

*They are easier to do business with. No self-respecting bank still opens at nine and closes at three, but too many bankers have that mentality, oblivious that their competitors are continually becoming more customer focused.

Aggressive financial service providers recognize that personal service often makes the difference between keeping and losing a customer. While bank employees often think that they are the reason you are there, Schwab's employees know that you are the reason they are there. Customers can spot the difference.

*They are more used to competitive markets. Banking, at least in the United States, has a history of not being very competitive and of profiting from regulatory protections. Most towns had room for two or three banks that happily shared the available business. Even when aggressive competitors came around, many bankers seemed unable to do anything except react by cutting price or buying a competitor.

To regain lost market share, banks must increase the expertise of their employees, make better use of customer information, become easier to do business with, and become more proficient at dealing with competitive markets.

The average return on equity for banks worldwide over the past 10 years has been about 10%, too low to attract investment capital. Banks are in a league with airlines and steel companies, as opposed to cosmetic, drug, and software companies.

The difference is in the ability to differentiate products. Banking is stuck in the commodity scenario: an airplane seat is an airplane seat, and a checking account is a checking account. When they do differentiate, bankers tend to think about products, when the key may be in service.

On the basis of research commissioned by Unisys and others, I see a serious disconnect between what customers are telling banks and what banks are doing.

Customers differentiate between institutions, while banks are trying to differentiate between products. Until banks better attune their efforts to what the customers value, banks will continue to be perceived as vendors of commodity products.

Of the four imperatives, bankers tell me they have the best handle on efficiency. All know their banks' efficiency ratio and most have a plan to bring it down. The problem is, there is no evidence that such a numerical approach will work.

The efficiency ratio compares noninterest expenses with the sum of net interest income and noninterest revenue. Nowhere can I find the kind of negative correlation bankers assume exists between noninterest expenses and return on assets.

It may sound outlandish to suggest that the way to increase ROA is to increase expenses, especially with the current emphasis on cost cutting, but that may not be far from the truth.

What we have learned from both observation and formal research by other organizations is that numbers-driven expense reductions invariably result in a deterioration of service levels, which leads to a loss of customer satisfaction and eventually to the loss of customers themselves.

The companies taking market share from banks, and able to differentiate themselves, are often more efficient than banks, but they focus on efficiencies in satisfying customers, not at meeting some financial ratio.

As for risk management, the recurring cycle of problems - country loans, leveraged buyouts, commercial real estate - should tip bankers off to the real issue. As margins narrow and pressure for earnings grows, bankers start looking for businesses where they can generate significant volumes in a short time with high margins. Not surprisingly, those businesses often generate significant losses about three years later.

Institutions that manage risk effectively accept the inevitability of the unknown - and of some unpleasant surprises.

This approach requires that banks use information in an entirely different way than they now do, processing large amounts of information and looking for aberrations from the predicted norm.

It requires a proactive approach to risk management, and it suggests that banks can use the loan underwriting process as a marketing tool to select the risks it wants to take, as opposed to a control tool for saying no to the ones it doesn't want.

Mr. Bollenbacher is manager of strategy and business development, worldwide financial services, at Unisys Corp., Blue Bell, Pa., and author of "The New Business of Banking."

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