How to Cut Costs for the Long Haul

Cost cutting is a hot topic in banking these days, a necessity brought on by a squeeze on profits. Much cost reduction, however, mortgages the future for short-term savings. By cutting 10% across the board, for example, banks end up cutting meat with the fat.

Furthermore, the efficiencies are not sustainable. Quick cost cutting has one-time benefits that often improve only one year's profitability. Management eventually will run out of rabbits to pull out of the hat. At that point, the bank's bottom line will finally reflect its true performance.

A strategic approach to cost management can achieve sustainable, lasting efficiencies, meshing with the overall strategic plan.

The Long View

Strategic cost reduction may take a long time to pay off. Reducing staff or working staff harder increases productivity short-term but may ultimately reduce employee effectiveness and increase the need for overtime and new hires. Lasting reductions can be achieved by giving staff better tools and by making each job simpler.

These improvements often involve investing time and money. If, for example, costs can be cut through better automation, the computer programming will take time.

Consider, for example, what is involved in automating the updating of a microcomputer-based asset/liability management system. A small bank may now spend two days of employee time per month key-entering maturity data. An automated interface to download the data can reduce this to minutes. But building the interface could take weeks of programming.

Once the new programs are available, manual procedures can be eliminated, staff can be retrained, and controls instituted. The end product is the opportunity to do the same amount of work in a lot less time.

In this example, the net effect of taking the long view is procedural simplication and retraining resulting in a new methodology and a sustainable reduction in staff expense.

Looking at the Whole

The strategic view means looking at costs in the context of the institution as a whole. It is necessary to look at interdepartmental dependencies to ensure that cost-control interventions in one area will not complicate operations in another.

Take the simple case of mail distribution. One typical cost-reduction step is to do less sorting at the central mail distribution department. Mail must then be fine-sorted in the operations departments.

This shifts the work without reducing it. You should not find yourself rearranging deck chairs on the Titanic.

Repenting at Leisure

And make sure you are not cutting too deep. For instance, if you want to eliminate selected reporting and control activities to reduce staff expense, make sure the activities are superfluous. If you later decide they were necessary, reestablishing them may cost more than having allowed them to continue in modified or reduced form.

In the case of a production function such as loan servicing, a change in a seemingly independent activity can have ramifications for other departments.

If, for example, collection is simplified by including remittance advices that allow barcoded entry of data on cash receipts, teller activities for manual payments can be affected in terms of volume and exception-processing work steps.

Large Banks and Small

Effective cost management requires attention to how competitors perform the same functions, and with what cost structures.

A small community bank, for example, should compare the unit cost structures of its products and services with the costs of competitors and the industry at large. The bank should then focus on coming in line with competitors.

Furthermore, banks should set their sights on cost management activities consistent with their size and capabilities.

For example, community banks should not set a strategic goal to be the lowest-cost provider of check clearing or commercial account services. Economies of scale derived from investing in the high-tech equipment and systems needed to provide these services at the lowest cost are justified by transaction volumes available only to the largest banks.

Focusing the Effort

Small banks are better served by focusing their cost management effort on areas that are not scale-sensitive but service-sensitive, such as teller services, for example.

The small bank should examine the services its competitors are providing, then seek to provide at least comparable services at a lower cost and, possibly a lower price.

For example, a small bank might choose to enhance its teller's ability to provide information to customers through the improvement of on-line inquiry screens at teller terminals, as opposed to seeking to reduce costs elsewhere. The customer would then receive quick, accurate information at lower cost.

Resource Allocation

This sort of analysis begins to touch on the question of resource allocation.

No institution has infinite resources to spend on reducing costs. The textbooks tell us that, all things being equal, if two investments in cost-saving interventions will yield any savings on a net-present-value basis, the institution should choose the project that will save the most.

But what if two projects would save the same amount?

Also, in the real world, resources to devote to all projects are truly limited. Which cost-saving project should the bank undertake, and why?

Consider two apparently even choices facing a bank that can afford to undertake only one.

* Option A is to fix loan processing software to streamline loan set-up procedures. The cost is $10,000; the resulting savings are $15,000 over two years.

* Option B is to fix teller-inquiry screens to allow faster, more accurate window services. The cost is $10,000; the savings are $15,000 over two years.

The obvious choice is B, all other things being equal. It not only yields cost savings but also will improve service.

Taking the strategic perspective will direct the cost-management decision toward areas that most enhance the bank's competitive position.

Monitoring and Reporting

Once the cost-reduction project is completed, the effectiveness of the effort must be monitored and the results reported to management continuously. This will enable management to correct problems and focus on quick solutions if costs begin to creep back up.

Toward that end the bank will need performance monitoring systems designed with this purpose in mind.

Costing systems throughout the bank should be geared toward the establishment of standard unit costs for each activity, product, service, and department.

While it is desirable to automate work-measurement structures and methods, this may may not be practical for smaller institutions. It is possible, however, to use manual cost-allocation models built with computer spreadsheets.

Lasting Savings

Even in the smallest institutions it will be necessary and beneficial to involve several individuals throughout the bank in the monitoring effort.

Taking the strategic perspective will ensure that cost-reduction projects will be properly prioritized and executed and achieve will lasting savings.

Cost cutting need not be a cumbersome or a "head-chopping" process. It can be a vehicle to increase profitability with existing resources and to reallocate available resources to get the greatest "bank for your buck."

Ms. Anat Bird is national director of financial institutions consulting at BDO Seidman, New York. Mr. Richard Israel is manager of the same unit.

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