This performance also results in an efficiency ratio of 40 percent, equivalent to Bank Cheapskate’s ratio. The Efficiency Ratio is calculated by dividing the bank’s non-interest expenses by their net income. 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. 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. mobile banking) is to create new processes that adapt to the way the technology platform works. circumstances facing each line of business and support function. 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. 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. 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. In our experience, banks that achieve significant productivity gains take the following five steps: Pinpoint where costs are today. 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. The following is a ranking of all banks in the United States in terms of "Efficiency ratio". 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. One of the best ways to review your processes is through a process mapping exercise. As with any community banking ratio, the efficiency ratio in itself may not be telling the whole story. Efficiency ratio = Noninterest Expenses/ (Operating Income – Loan Loss Provision) 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? 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. 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. Electronic documents can move from step to step with minimal delay and virtually no added cost. As with any business, banks must be vigilant about spending wisely. 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. Bank operations will evolve towards greater entropy if not managed. Other basic cost-cutting techniques include consolidating vendors and benchmarking costs against comparable services in the market. Beyond the Efficiency Ratio: Leveraging Automation to Improve Profitability and Experience - Banking Exchange 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. One of the best ways to review your processes is through a … For a larger version, click on the image. 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. Improving the operating efficiency ratio for banks: Overlooked support groups. Once your process improvement initiatives are complete, don’t stop there: Create a culture of continuous improvement at your bank so that every employee is prepared and motivated to maintain the cost savings of your initial efforts. One way is to charge more which you can always do. One of the methods of measuring the effectiveness of a credit union is the Efficiency Ratio. This means that it costs Bank XYZ $0.50 to generate $1 of revenue. 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. Improve Cost Efficiency Change from within to improve profitability essentially means improved operational efficiency and productivity. For instance, take the comment that the industry standard for the efficiency ratio is in the mid-to-low 60%s. A lower efficiency ratio indicates that the bank is earning more than it is spending. Even more important, electronic imaging allows parallel processing of documents so that several steps in a transaction’s progress can be completed simultaneously. 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. 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. Change the Internal Culture. Your efficiency ratio is your expenses/revenue ratio. The lower the ratio, the better. You are looking at your company’s liquidity ratios and you are concerned. are more than is needed in areas that already are productive and are not 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%. Small Banks Tighten Belts To Improve Efficiency Ratios January 11, 1999, 2:00 a.m. EST 3 Min Read 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. We will assume that most unneeded costs are already cut. 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. ratio, and increase in the base capital requirements. Fraud, Compliance, Marketing… these back-office support groups are often overlooked when it comes to finding new ways to improve productivity in banks. 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. Bank of America achieved an operating leverage of 500 basis points in 2Q17. Such cuts typically While the two ratios are the same, it is unlikely that most institutional investors will value them equally. focusing their efforts. The value of the net revenue is found by subtracting a bank's loan loss provision from its operating income. can’t afford to stay with the current model of continually adding to your in-house Compliance, Risk & Audit Department. mobile banking) is to create new processes that adapt to the way the technology platform works. Continued inefficiency at a bank might be robbing important efforts of the resources banks need to be fully successful. There is a strong correlation between efficiency ratio and return on assets (Exhibit 2), and banks that reduced their efficiency ratio aggressively over recent years have seen substantially higher share-price appreciation and return on equity improvement than peers (Exhibit 3). Some banks assertively promote electronic account openings, remote deposit capture via smart devices, and accounts that are designed to be virtually paperless. Formalize Strategy: No bank falls into a 45% efficiency ratio by accident. Improve Your Bank’s Efficiency Ratio By Focusing On These 4 Areas. Bear in mind as well that vendor relationships can have an effect on regulators’ view of the institution’s risk profile. This comparison is based on data reported on 2020-09-30. 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. Changes in customer preferences and expectations, new competition, and new technologies are transforming the nature of banking. For regional banks, efficiency-ratio improvement should be a top agenda item for 2019. They are not as high as they should be and this is not good. It’s calculated by dividing the bank’s Non-Interest Expenses by their Net Income. 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%. 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. Banks Ranked by Efficiency ratio. Yet huge opportunities invariably exist. Again, an impressive performance. Reduce cycle time. 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. 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. These ratios … 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. With the banking industry facing low margins and hefty compliance investments, banks need to remain vigilant and keep costs well under control. 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. 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. So how can a bank move toward such outcomes? To calculate the efficiency ratio, divide a bank’s expenses by net revenues. The most successful efficiency 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. However, you always need to consider a bank's strategy, business mix, and economies of scale as well. They expected—and the technology vendor promised—operational efficiency gains … 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% 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. prioritizing their impact based on current costs. 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. budget cuts inevitably are a recipe for disaster. 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