Virtually every analyst who follows the banking industry agrees that once loan quality has been brought under control, the best way to increase share price is to lower the efficiency ratio. Every one-point drop in the efficiency ratio for a $10 billion-asset bank adds $5 million to pretax income.
The $10 billion bank whose efficiency ratio drops from 65 to 55 adds $50 million to earnings and increases earnings per share, and presumably stock price, by 30% to 50%.
Why is it, then, that only a few banks have efficiency ratios in the low 50s, even high 40s, while most banks are in the 60s, 70s, and higher?
Why haven't banks really attacked efficiency and brought their ratios down when so much is at stake?
Weed Out the Waste
The answers lie mainly in the fact that banking as a whole is engulfed in inefficiency. Even the most efficient banks routinely find activities that add no value and can be eliminated. Any bank in the country can get into the mid- to low 50s, and every one that isn't there is wasting money in ways the senior officers of the company can not even imagine.
Consider the case of the mysterious "Max Kahn Report," prepared every month by a highly touted bank for one of its vendors, Max Kahn Co.
Several people in the bank worked each month preparing the report, until, eventually, someone asked enough questions about what purpose it served to learn that not only had the bank not done business with the Max Kahn Co. for three years, but Max himself had died two years earlier. The report was discontinued that day.
At one of the largest, most profitable banks in the country, the mail deposit unit formed two years earlier continued to meticulously record every detail of every mail deposit on five-by-eight cards, thousands of which were kept in six huge filing cabinets.
The reason? Helen, the telephone operator, and several of her staff who were previously responsible for mail deposits were located at the other end of the building and did not have easy access to the central file records, so they started their own card file.
Since the people in the new mail deposit department could walk 10 feet to the central file, no one needed or ever used the information recorded on the index cards. But the file, which consumed 70% of the group's time, was kept current until someone finally asked, "What are we doing and why are we doing it?" The card files were thrown out the next day.
A highly respected super-regional, whose efficiency ratio is about 55%, had an elaborate system in one of its regions for handling credit inquiries.
Four clerks took calls, recorded detailed information on scratch paper, typed formal replies to the inquiring creditor, made and filed photocopies of the replies in alphabetical order in file folders kept in each clerk's desk, and recorded the entries on index cards - which were also filed in alphabetical order by customer name in a master file in the back room.
The clerks did an excellent job in every aspect of this process. Everything was extremely neat, professional, and thorough. But, 80% of what they were doing didn't have to be done at all.
No one ever used any of the information in any of the files, and the letter received by the inquiring creditor was always thrown away. After checking with the legal department, the paperwork was eliminated entirely, freeing up the staff for other jobs.
A midsize bank had just been ranked in the top 10th percentile in efficiency by the American Banker. But its back office was filled with jobs in which clerical people were maintaining manual reports for information that had already been automated.
In fact, three operational units consisted mostly of people who were copying information that no one ever looked at. Why? Because the ledgers had always been kept, going back 15 years or more. When the stacks and stacks of file boxes housing the manual ledgers were piled on the boardroom table in front of the president of the bank, he almost passed out.
Keep in mind, these examples are all from relatively efficient banks. And while the subject may not stir the imagination of most red-blooded bankers, the fact is that inefficient practices and processes are costing banks a fortune. In many banks, more money is wasted than is earned for the shareholders.
Banks with the best handle on efficiency are those with a long history of watching the details and having a culture that questions the value added of everything that's done or spent.