The new mid-market benchmark for bank efficiency ratio

In our 2019 report, Driving Down Bank Efficiency Ratio: Despite Digital Adoption, Vast Improvements Remain, we found that mid-market banks—entities with $1 billion to $250 billion in assets—were overwhelmingly aligned around the need to boost productivity by leveraging digital technology. When we looked deeper, however, our report revealed an important contradiction: an industry aligned around leveraging digital technology to boost productivity, but also one that is still failing to meet analog standards of optimal efficiency ratio. 

In our survey of over 150 bank executives, we found boosting productivity to be the top strategic priority at mid-market banks. When asked how they would boost productivity, digital technology emerged as the primary driver. Despite the consensus, banks are not making productivity gains at the pace of an increasingly digital industry. Nearly 80% of our survey respondents perceived that they have been extremely or very successful in improving efficiency/productivity at their banks in the past year, but only 34% have an efficiency ratio at or below 50%. In fact, from 2015 to 2018, less than 20% of mid-market banks have shown a five-point improvement in efficiency ratio; less than 10% have made 10-point improvements.

In fact, we posited that an industry in which digital technologies enable more end-to-end online transactions and fewer branch locations, and where automated processes speed up and streamline operations, the rules of efficiency ratio were primed to be broken.  

In the months since launching our report, we set out to determine if optimized technology investments could lower efficiency ratio. We also wanted to test the possibility of lowering efficiency ratio beyond a mere point or two, but instead by 10+ points—and in a matter of months. Working with a $5 billion regional bank, we modeled a reduction in efficiency ratio by 12 points to be achieved in 12-18 months.  

Our original 2019 report solidified the mid-market’s willingness to embrace digital technology to boost productivity. But more recent events in 2020 have only highlighted the urgency for the mid-market’s embrace of new digital tools and automation. In our new reality of remote work and digital client interactions, the 2020 economy has essentially forced the mid-market’s hand. 

In light of our new economic realities and our recent efforts, we predict the mid-market is capable of producing a new benchmark efficiency ratio of 40%, toppling old standards and allowing us to reimagine what is possible. 

Banking technology: A new approach to a tested methodology 

When it came time to test our theory of just how much—and how quickly—one could lower efficiency ratio, we leveraged a version of a tried and true methodology aimed at organization transformation.  

Our methodology may not seem remarkably different from other transformation projects. But our approach did diverge from past experiences. Instead of taking a “top-down” approach to applying this methodology, given tools and capabilities available, we started from the bottom and looked at foundational infrastructure and operations to pinpoint exactly where the bank had excess costs and unproductive time. We found this bottom-up approach led to more concrete road map to capture opportunity with focused, actionable recommendations impacting the broader organization and not just one line of business or department.  

This approach allowed us a view into the entire organization, identifying opportunities that may have gone unnoticed or deprioritized. For example, a bank that drives most of its revenue from commercial lending may be focused on making that line of business efficient. But by only focusing on a single functional area, the bank may be missing out a larger delta and gain from improvements in HR operations or procurement. 

The enterprise-wide view allowed us to capture a much broader data set, which led to more detailed modeling and pinpointed recommendations. That broader data set also enabled a dialogue from various stakeholders across the bank, allowing them to align on priorities and achieve a broader consensus.  

Assess the enterprise: We completed an assessment to understand where opportunity for efficiency existed within our client’s organization, the value associated with each opportunity, and then developed a road map on how to capture the value identified. We dug into understanding the bank’s business and technology strategies and the current landscape of the organization by reviewing key functions and cost centers such as IT strategy, documentation, income statements and non-interest expenses, and the technology/application landscape. A full assessment is critical step to identifying true value and to capture the estimated ROI.  

Shift the bank’s strategy: With a focus squarely on improvements to lower the efficiency ratio, banks must think big and include lofty goals for truly transforming the bank, including re-imaging how all roles, —including leadership—work within the new organization. Teams that are successful in reimagining their business and accompanying strategy are ones that design holistically but start small and test proof of concept projects to learn and adjust as needed.  A test-and-learn approach allows banks to ensure goals across the enterprise are aligned and to understand quickly where priorities might conflict and how to resolve those challenges. Enterprise-wide alignment is essential given the scope of change and impacts to ways of working.  

Invest in foundational improvements: Many banks feel more comfortable taking on the transformation with one initiative at a time to minimize upfront costs. We find this traditional approach can cause banks to not realize synergies gained through a full-scale transformation, and results lag. We recommend banks start by identifying a road map or large-scale plan but execute with more agility to generate quick, smaller wins along the way. This approach differs from the standard implementation playbook in that it takes into consideration a broader strategy—not a single tool or implementation like a CRM—but implements through accelerated, iterative phases. The result is pinpointed, not piecemeal execution of strategy.    

Achieve process optimization and automation: Much like our 2019 report found, the key to making significant strides in improving your efficiency ratio is through digital technology and automation. When approaching automation in our test case, we sought to ensure the customer’s perspective formed the basis for all improvements by transitioning customers to digital/scalable offerings and sunsetting outdated products and systems. Banks that leverage automation and digital banking become more nimble, in addition to more efficient—able to more quickly adapt to outside factors and adjust to new realities than their peers.  

Scale and grow the organization: We believe that while cost cutting alone has the potential to lower efficiency ratio by 10s of points, we can’t lose sight of the ability to lower efficiency ratio through revenue lift. With operations now more scalable, enhancing revenue through new products, enhanced services or entry into new markets should also be considered. In other words, with a nimble, scalable organization behind you, volume, volume, volume is the approach at this point.  

Apart from pinpointing and modeling precise improvements in technology and operations our bank partner needed to make to lower efficiency ratio by double digits, we are moving forward with two takeaways any bank seeking to lower efficiency ratio must bear in mind: 

1. Bank leadership must be aligned around investment and opportunity. In plain speak, the upfront investment to modernizing, digitizing, and optimizing enterprise-wide operations is significant and bank leaders must be aligned on not only the costs of the initial investment but also the ROI. 
    
   We chose to measure ROI primarily through a lower efficiency ratio, but other returns will be seen across the enterprise and bank functions. From improved customer experiences, new ways of working in the face of automation, and new tools and technology, organizational improvements beyond just efficiency ratio will be significant. The ability to model and pinpoint not only investments but also the value of these investments is critical in gaining alignment of stakeholders and bank leaders. 
    
   Beyond executive support, projects of this scale require teams that can evaluate projects and decide which project to pursue and when to pursue it. A project evaluation structure or mechanism that functions alongside an established Project Management Office is essential.  
   
   
2. Technology alone is not a silver bullet. Banks need a strategy to match their technology investments. It’s not enough to simply invest in new technology to improve an efficiency ratio. Without a considered, strategic approach to how technology will be implemented and utilized by the people working with and alongside it, those technology investments will always fall flat.

Conclusion

Banks are on the right track prioritizing digital technology as a means to boost productivity. But success still hinges on the ability to lower efficiency ratios through fully optimizing those tech investments. We think mid-market banks can achieve results beyond the traditional benchmark, but only if they invest in the change required—both in embracing digital technology and changing the way we work alongside it.