On efficiency ratios, banks should aim lower – and digital can lead the way
Mid-market banks are laser-focused on driving down efficiency ratios, and almost all of them view tech investments as key to hitting their targets.
But many of these same banks are still trapped in old ways of thinking about what’s possible, often aiming for a 50% efficiency ratio at best, according to a recent survey by West Monroe Partners and American Banker Magazine.
As new digital tools and fintech capabilities become available to mid-market banks, a new rule book is being written around the standards for banking efficiency. Soon, market leaders will routinely achieve efficiency ratios below 50%, and banks still aiming at this old efficiency standard will struggle to compete.
West Monroe and American Banker found a gap between the importance banks place on improving efficiency and their effectiveness in actually achieving a competitive efficiency ratio,
Nearly 80% of our survey respondents perceive that they have been extremely or very successful in improving efficiency/productivity at their banks in the past year, but only 34% have achieved an efficiency ratio at or below 50%. From 2015 to 2018, less than 20% of mid-market banks have managed a five-point improvement in efficiency ratio.
And during a time when digital innovation is transforming business operations, only 40% of banks say they are pushing to achieve efficiency ratios under 50%. The same number of respondents, 40%, say they are still aiming for a ratio above 60%.
This despite the fact that 98% of survey respondents say they are implementing strategies to improve efficiency, 50% say efficiency is their top priority, and 61% say they will use digital technology to get there
Why it’s time to think beyond the 50% efficiency ratio
What explains this divide between ambition and reality? Why aren’t banks’ digital investments paying off in operational efficiency gains?
It helps to understand how the 50% efficiency ratio standard came to be. That standard was built around a business model that depended on large numbers of physical branch locations, high numbers of in-house regulatory experts, large customer service and call center staffs, and technologies that encouraged more, not less, manual labor.
Today new technologies — robotic process automation, smart analytics, and flexible software architecture — are turning conventional wisdom on its head, and drastically altering these traditional high-cost models.
Forward-thinking bank executives are looking to enhance the branch model and enable more end-to-end online transactions; adopt technologies that absorb repetitive tasks and manual labor; and deploy bots to augment human workers in the regulatory and customer service departments.
These shifts are causing profound changes in expectations across companies, from the role of humans in back offices to expectations of executives and shareholders.
The key to realizing gains from technology
But the new technologies are just tools. Realizing major gains in efficiency requires redesigning business processes along the way, engaging the entire workforce in a targeted and repeatable process that moves bots from concept to pilot to full implementation, in a way that maximizes gains in efficiency.
This means focusing on functions with the highest efficiency ROI, which is another point of industry uncertainty. The West Monroe-American Banker survey found little agreement between banks on which functions were most likely to drive efficiency improvements: 48% of respondents say their company’s information technology function is an efficiency driver; 44% see promise in their operations function and 37% in risk management and compliance.
While an updated IT architecture is fundamental to taking advantage of new tools that help reduce efficiency ratios, the greatest opportunities to push beyond the 50% efficiency ratio is by focusing on operations and risk management.
Middle market institutions are still doing a tremendous amount of re-keying of data because integration between systems just doesn’t exist, meaning someone has to feed it through the litany of back office platforms.
And risk management and compliance departments remain largely unchanged from the years immediately following the recession, when new regulations came down, and most banks threw bodies at ensuring compliance. Technology such as RPA can help banks put some of those bodies to work in other, more productive functions.
Time to go all-in on digital transformation
It’s worth noting that banks are aware that they have yet to make the most of their digital investment: 91% of survey respondents indicate a high level of technology acceptance, but 43% report the technology is not being used to the fullest potential at their institutions.
Now is the time for banks to go all-in on their digital transformation strategies, from internal operations to customer experience. The curve for middle market institutions will be steep for a few years, and those institutions that can persevere through change management will move the needle on productivity and efficiency.
Aiming for efficiency ratios below 50% would have seemed like a fantasy just a decade ago. Even a few years ago, it may have seemed overly optimistic. But today, it represents a necessary commitment to putting a banking institution in a position to survive and thrive for decades to come.
