Most banks that are considered ‘efficient’ operate between 50% and 60%, and measure this as a part of their earnings statements. In our experience, banks that achieve significant productivity gains take the following five steps: Pinpoint where costs are today. focusing their efforts. From the findings, there was a fall in efficiency ratio from 2008 to 2012 in banks indicating that the banks were making considerably more than they were spending thus depicting a sound fiscal footing. Bank-Specific Ratios Bank-Specific Ratios Bank-specific ratios, such as net interest margin (NIM), provision for credit losses (PCL), and efficiency ratio are unique to the banking industry. Improving Efficiency Ratios in Banks Webcast - May 2011 Abstract: Sheila Shaffie, a Master Black Belt and Lean Six Sigma expert, shares how banks and financial institutions can address some of their toughest challenges, and substantially improve efficiency by implementing Quality and … The bank garnered a 60% efficiency ratio, compared to 63% in 2Q16, which reflects lower spending. All initiatives designed to improve operational efficiency ratios will fail if the right corporate culture isn’t in place. initiatives follow a more analytic approach that reflects the specific These processes or workflows should be the most influential on your bottom line while also being the simplest to improve – thus making your work as cost-effective as possible.Then, use a process improvement methodology to drive sustainable cost improvements for these particular processes. While the two ratios are the same, it is unlikely that most institutional investors will value them equally. This means that it costs Bank XYZ $0.50 to generate $1 of revenue. Yet huge opportunities invariably exist. This comparison is based on data reported on 2020-09-30. These ratios are used by management to help improve the company as well as outside investors and creditors looking at the operations of profitability of the company. These factors put exceptional pressure on banks’ operating budgets and generate an understandable appetite among executives for strategies to reduce expenditures in some areas in order to afford the necessary expenditures in technology, marketing, and new capabilities to remain competitive. Following are six strategic areas where today’s industry leaders are Fraud, Compliance, Marketing… these back-office support groups are often overlooked when it comes to finding new ways to improve productivity in banks. A balanced approach – one that enables a bank not only to improve operating efficiency but also to upgrade its capabilities to respond to market needs and prepare for the future – is imperative to the success of a bank’s operations and profitability. As with any business, banks must be vigilant about spending wisely. Channel optimization should not be about branches alone, as contact centers, online and mobile banking, ATMs, and relationship managers also are important channels for customers. Types of efficiency ratios - Accounts receivable & Inventory turnover, Accounts payable turnover, Working capital turnover, Fixed assets & Total asset turnover ratios. For regional banks, efficiency-ratio improvement should be a top agenda item for 2019. Again, there is no one-size-fits-all approach. For instance, take the comment that the industry standard for the efficiency ratio is in the mid-to-low 60%s. As financial institutions race to improve their operating efficiency ratio, here are some strategies you can use to ensure your people, processes, and technology give your team a competitive edge. To Improve a Bank’s Efficiency Ratio, Invest in Digital Technology – and Your Employees West Monroe Partners' new study reveals only 34% of mid-market banks have an efficiency ratio at or below the optimal 50% Even more important, electronic imaging allows parallel processing of documents so that several steps in a transaction’s progress can be completed simultaneously. Bank Topline reports $50 in expenses and $125 in revenue in its most recent quarter. Reduce cycle time. There are two ways you can improve your ratio: 1) Increase Revenue – the easy way is to achieve this is to serve more customers – There are a number of ways you can Increase Revenue. can’t afford to stay with the current model of continually adding to your in-house Compliance, Risk & Audit Department. We interviewed hundreds of top performing banks, looked at the data and have experimented with various ways to improve efficiency. So how can a bank move toward such outcomes? A lower efficiency ratio indicates that the bank is earning more than it is spending. The Efficiency Ratio is calculated by dividing the bank’s non-interest expenses by their net income. An efficiency ratio of … The lower the ratio, the better. A mixed model helps you manage your banking compliance requirements more cost-effectively. To calculate banking efficiency ratio, divide the total non-interest expense incurred by the bank by the total revenue (interest and non-interest income) generated by the bank over the same period of time, as a percentage. This requires a visible commitment from top management to balance value and cost, reduce unnecessary expenditures, and implement metrics and accountability that encourage individual attention to efficiency improvement and profitability. But there are a few banks that have identified a full range of levers and developed plans to apply them across all of their processes, putting them in position to achieve efficiency gains of 30 percent or more. The goal is to improve the bank’s efficiency ratio by reducing the unit cost-to-value ratio of each activity or transaction – such as the cost of opening an account, creating a loan document package, or handling a specific type of transaction. Your first steps should focus on the following four areas: Select a few end-to-end processes that need improvement by prioritizing their impact based on current costs. But this approach is hurting your bank’s efficiency ratio rather than helping it. Banks currently seeking to improve efficiency ratios need to heed these lessons. The ratio tells how well a credit union is using their assets to generate profits. It’s calculated by dividing the bank’s Non-Interest Expenses by their Net Income. In other words, the Efficiency Ratio with 50% being optimal, indicates whether banks have an efficient cost structure. One of the best ways to review your processes is through a process mapping exercise. The ratio is designed to be a normalized measure of the bank’s ability to turn resources into revenue and is used as a benchmark against peers. For example, automated workflow processing gives managers greater visibility into the activities being performed, allowing them to monitor work queues, identify bottlenecks or problems, and reallocate work to respond to changing conditions. Part of improving the ratio is to drive down the costs of operation. The higher the ratio the healthier the business. So, how do you keep your efficiency ratio from creeping into the 70s and 80s (or higher) when it should be in the 50s or 60s? improving your bank’s efficiency ratio is through data analysis, Outdated or inefficient banking operations and workflows, Costly implementation of new technology systems, Increased banking compliance requirements. For many banks, their approach to buying a new technology or system (e.g. eliminated any overlapping activities and incorporated improvements directly into your new workflow. Banks are working to enhance their contact centers via better operating hours and technical knowledge, as well as their chat, text, and social media capabilities in order to meet customers’ changing expectations. mobile banking) is to create new processes that adapt to the way the technology platform works. Small Banks Tighten Belts To Improve Efficiency Ratios January 11, 1999, 2:00 a.m. EST 3 Min Read Such cuts typically Efficiency Ratios are a measure of how well a co. is managing its routine affairs. To calculate the efficiency ratio, divide a bank’s expenses by net revenues. But a focus on cutting costs alone is not a formula for long-term success. Electronic documents can move from step to step with minimal delay and virtually no added cost. One way is to charge more which you can always do. Instead, you need to incorporate your compliance and risk management requirements into your workflow improvements.Your ideal workflow should improve compliance efficiency, customer service and risk management activities. To remain competitive, banks need to invest in technology, marketing, automation, and self-service capabilities, and also must optimize their legacy investments in branches and traditional systems. They expected—and the technology vendor promised—operational efficiency gains … In summary, the efficiency ratio is a compact, easy ratio to analyze a bank's cost efficiency. Bear in mind as well that vendor relationships can have an effect on regulators’ view of the institution’s risk profile. Efficiency ratio = Noninterest Expenses/ (Operating Income – Loan Loss Provision) For a larger version, click on the image. For example, if Bank XYZ's costs (excluding interest expense) totaled $5,000,000 and its revenues totaled $10,000,000, then using the formula above, we can calculate that Bank XYZ's efficiency ratio is $5,000,000 / $10,000,000 = 50%. Formalize Strategy: No bank falls into a 45% efficiency ratio by accident. circumstances facing each line of business and support function. With the challenges banks are facing these days, it’s becoming clear that banking executives must get the best “bang for the buck” from all resource expenditures. To permanently improve efficiency and cost effectiveness, bank management must go beyond the efficiency ratio and focus their efforts on the following: Reducing unit costs for specific products and processes ; Managing unneeded capacity in operating areas and channels; Optimizing the cost of delivering quality service Before you adopt a new technology platform, first review your affected end-to-end processes to ensure the new technology or system actually improves your banking operations, rather than just adding to them. To accomplish them, the bank invested in a high-volume loan-underwriting workflow technology. A monthly newsletter that features timely information from industry specialists. After that, we have distilled the below six ways to best effect efficiency performance. Ultimately, organizational success and improved bank profitability require more than just efficiency. All of these changes are occurring in an industry environment that is experiencing narrowing margins, slow deposit growth, and the potential of an economic downturn. are more than is needed in areas that already are productive and are not A successful bank must be able to provide customers with value and service at a competitive price with costs that still generate an acceptable return. In fact, the opposite happens. Looking beyond the six specific cost-saving strategies discussed here, it’s important to recognize that long-term efficiency is impossible to achieve without a corporate culture that supports and values it. Today, however, the banking industry faces a new combination of circumstances that are giving special impetus to the need for efficiency. Similar to companies in other sectors, banks have specific ratios to measure profitability and efficiency that are designed to suit their unique business operations. One simple improvement to make this a reality is to use new technology platforms in order to automate compliance tracking, data gathering, controls monitoring, data validation and risk monitoring.You should also contain compliance staffing costs with new sourcing models that mix in-house and outsourced resources. The value of the net revenue is found by subtracting a bank's loan loss provision from its operating income. Whether you’re a middle-market bank or a financial institution of a different size, banking compliance is a huge cost you can’t afford to ignore, but you also can’t afford to stay with the current model of continually adding to your in-house Compliance, Risk & Audit Department. Since a bank's operating expenses are in the numerator and its revenue is in the denominator, a lower efficiency ratio means that a bank is operating better. The following is a ranking of all banks in the United States in terms of "Efficiency ratio". This performance also results in an efficiency ratio of 40 percent, equivalent to Bank Cheapskate’s ratio. Continued inefficiency at a bank might be robbing important efforts of the resources banks need to be fully successful. Benchmark Ratio #5: Current Ratio One of the first steps to take when implementing process improvement at your bank is to communicate to your team the value of a low efficiency ratio, how you calculate it and what trends your ratio has recently experienced. Other useful tools include visible metrics and performance charts along with “line-of-sight” incentives – such as bonuses that are directly related to individual or team performances and practices, not just institutional performances. We will assume that most unneeded costs are already cut. Across-the-board Bank of America achieved an operating leverage of 500 basis points in 2Q17. enough for the most inefficient areas. Let your team know that you’re undertaking process improvement steps to decrease your efficiency ratio, and also let them know what parts you plan to have them play in those steps. These ratios … Some banks assertively promote electronic account openings, remote deposit capture via smart devices, and accounts that are designed to be virtually paperless. The business of banking is morphing toward a digital- and technology-based model while retaining important aspects of the traditional person-to-person business model. Becoming more efficient in everything they do is an important strategic objective for banks, and most banks already put forth significant effort to improve their costs after the last recession. Achieving a lower efficiency ratio can be accomplished by pulling many different levers, including insurance. With the banking industry facing low margins and hefty compliance investments, banks need to remain vigilant and keep costs well under control. Exhibit 1. Your efficiency ratio is your expenses/revenue ratio. Bank Efficiency Ratio = Expenses* / Revenue *not including interest expense. Change the Internal Culture. Other banks – often those with large commercial customers – pursue a fundamentally different approach, focusing on personal service with a relationship manager and support team assigned to each qualifying account. prioritizing their impact based on current costs. The high-value business generated by this approach can more than offset the added costs. As with any community banking ratio, the efficiency ratio in itself may not be telling the whole story. Balance the workload across employees in multiple locations. The findings revealed a significant positive relationship between Return on Asset and Efficiency. Banks Ranked by Efficiency ratio. One of the methods of measuring the effectiveness of a credit union is the Efficiency Ratio. These are certainly laudable goals. Improve Your Bank’s Efficiency Ratio By Focusing On These 4 Areas. The most successful efficiency Making efficiency improvement a formal strategy, executing branch transition, digitize various processes, and improving both your customer and product mix can easily drop efficiency below 45%. Again, an impressive performance. Improve Cost Efficiency Change from within to improve profitability essentially means improved operational efficiency and productivity. budget cuts inevitably are a recipe for disaster. An efficiency ratio … Changes in customer preferences and expectations, new competition, and new technologies are transforming the nature of banking. But this approach is hurting your bank’s efficiency ratio rather than helping it.Before you adopt a new technology platform, first review your affected end-to-end processes to ensure the new technology or system actually improves your banking operations, rather than just adding to them. Then, once you’re ready to integrate a new technology platform, a process map ensures that you’ve already eliminated any overlapping activities and incorporated improvements directly into your new workflow. mobile banking) is to create new processes that adapt to the way the technology platform works. Many institutions also find success in redefining job roles, using more flexible work arrangements, providing mobility for off-site work, and outsourcing more specialized activities. However, you always need to consider a bank's strategy, business mix, and economies of scale as well. Efficiency ratios often look at the time it takes companies to collect cash from customer or the time it takes companies to convert inventory into cash—in other words, make sales. In many instances, of course, using electronic signatures, signature pads, and online processes can eliminate paper altogether – thus taking one more step out of the process. There are approximately 300 banks in our industry that consistently produce below a 45% efficiency ratio. For many banks, their approach to buying a new technology or system (e.g. Efficiency ratios of the leading banks of the Standard & Poor's 500. Beyond the Efficiency Ratio: Leveraging Automation to Improve Profitability and Experience - Banking Exchange Improved planning for regulatory capital through the internal capital adequacy assessment process coupled with a holistic evaluation of taxation implications and the regulatory efficiency of capital instruments is important to support long-term return on equity expectations. But, as with many community banking ratios, it may be the reason to dig deeper into the puzzle! Other basic cost-cutting techniques include consolidating vendors and benchmarking costs against comparable services in the market. You are looking at your company’s liquidity ratios and you are concerned. One increasingly important practice is to convert all hard-copy documents into electronic images as early as possible in a transaction or process instead of as a final document storage step after the transaction. Getting your efficiency ratio … One of the best ways to review your processes is through a … Improving the operating efficiency ratio for banks: Overlooked support groups. Blind pursuit of immediate and tangible productivity gains will lead to banks learning how to do all of the wrong activities very efficiently, while more nimble competitors continue to take market share with more relevant offerings. ratio, and increase in the base capital requirements. sure on banks to improve their earnings and to control costs. They are not as high as they should be and this is not good. 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