Efficiency ratios may be a preferred measure for financial markets to evaluate the performance of banks, but they may be an obstacle to the strategic decisions that banks must make to support new delivery systems.

The application of efficiency ratio analysis to alternative delivery systems like off-premises automated teller machines has given nonbank processing organizations an opportunity to gain control over the most important element of the payments system: customers' direct relationships with their banks.

For all intents and purposes, the retail card-based payments system is already controlled by nonbank processors like Nabanco. Organizations like Electronic Data Systems and Affiliated Computer Services are within reach of similarly gaining control of the ATM-based payments system, which almost 40% of customers use to interact with their banks.

In 1993, EDS won the contract to place approximately 4,000 ATMs at 7- Eleven stores across the United States. In one fell swoop, the company captured almost 14% of all U.S. ATMs away from bank premises. Not many banks have been able to keep up.

Quite by accident, financial institutions are placing themselves at a serious competitive disadvantage by doing what they perceive to be the right thing. The long-term consequences for the banking industry could be severe.

In planning an integrated delivery strategy, it is important to evaluate an off-premises ATM as a potential substitute for branch activity. Unfortunately, few banks have quantified the contribution that an ATM actually makes.

In many cases, banks segregate the revenues and costs of operating an ATM-based delivery system in such a way that it is almost impossible to determine if the system is profitable. Thus, it is highly unlikely that the system is being run as a business.

In fact, the business case for off-premises ATM deployment is very attractive. Revenue potential can be substantial, especially in states that allow surcharging. A surcharge of 50 cents per transaction reduces risk substantially. If an ATM's breakeven volume is 2,500 transactions with no surcharge, a 50-cent surcharge can lower that threshold by 33%, to 1,675.

It may be important to use an efficiency ratio to evaluate off-premises ATMs, but only in the context of the overall bank's performance. By themselves, few off-premises ATMs can perform at efficiency ratios below 50%, given their relatively high fixed costs. But because many banks use a stand-alone efficiency test, off-premises ATM decisions are either rejected or delayed.

Nonbank processing organizations do not seem to be encumbered by such measurement constraints, and consequently tend to move faster in this area. The result, unfortunately for banks, is that these organizations capture attractive retail sites. Once in, they are not easily dislodged.

These competing organizations are not particularly concerned with either displacing branch activity or passing an analyst's efficiency test. They evaluate off-premises ATMs very differently, and they find a very attractive business proposition.

Here are four reasons:

* They are not concerned with deposits. By deploying cash dispensers that are less expensive than full-function ATMs, nonbanks can cut capital costs by as much as 50%. In most markets this is a powerful advantage, as deposits account for less than 15% of total transactions.

* They leverage existing operating cost structures, and in many cases have significant scale advantages. Processors like EDS have systems in place and enormous volume with which they drive down the cost of incremental activity.

* They are less concerned about the impact of surcharges on their customer relationships. Processors can add surcharges with impunity because their relationships are based on a simple proposition - cash access with higher convenience and after-hours security (at retail locations), but at a higher cost.

* They are not bound to any particular geography. Operating nationally, the processors can sign blanket agreements with multistate retailers with hundreds of locations. This provides a deployment advantage over all but the largest banks.

Many banks that have implemented off-premises ATM strategies have discovered their fee-generating and profit-enhancing potential. For major ATM owners with a large number of existing terminals, the low incremental investment can produce returns as high as 80% over a five-year period. Efficiency ratios, however, do not approach the magic 50% until year five.

Off-premises ATM deployment is the tip of the delivery-systems iceberg. Home banking will bring an entirely new and potentially very powerful set of competitors into the payments system.

Banks will have to stand their ground if they are going to maintain any semblance of control over the payments system. Efficiency ratios may be the measure of choice among analysts and chief financial officers, but as a stand-alone measure for delivery systems they may do more harm than good as the competition unfolds. Mr. Dove is president of the Boston-based consulting firm that bears his name. Ms. Ishida is research associate.

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