By D. Robley Wood, Jr., and Glenn H. Gilbreath
Virginia Bankers Magazine June 2009: Is there a payoff for emphasizing selected operational practices? To find out, the Virginia Bankers Association (VBA) and researchers from Virginia Commonwealth University conducted a study examining the relationship between bank financial performance and the emphasis on operational practices touted as critical success factors.
The initial results from the Bank Practices Survey have now been released and the results are clear. In the current economic environment, one clear critical success factor for Virginia community banks is a strong emphasis on expense management throughout the bank. Although other critical success factors – such as quality, dependability, relationship building and convenience – are always worthy of attention, an emphasis on controlling expenses trumped all other factors.
About the 2007-2008 Bank Practices Survey
The survey was mailed to senior executives in every community bank that is a member of the VBA. As always, the support of the VBA’s membership was outstanding, with officers from 57 percent of the community banks and holding companies taking time to complete the survey.
Approximately 90 percent of the response came from the highest level of bank management. A majority of the responses, 60 percent, came from the president and/or CEO, and an additional 30 percent of the responses came from the chief financial officer or chief operating officer.
Banks open less than five years were excluded from the analysis, since their financial performance would not likely be representative of the more typical Virginia community bank. Sixty-four banks were analyzed for this article. The average bank in this study had been in business for 62 years (23 percent had been operating for five to 10 years and 29 percent had been in business for at least 100 years).
The emphasis a bank places on selected operational practices was determined by the responses to 46 statements that measure various dimensions of critical success factors. These factors include customer relationship building, improving service quality, retaining employees, expense control, services available, employee training and convenience. The scores for all banks on each factor were used to divide the banks into three groups: those placing a high emphasis on that factor, those with an emphasis in the middle of the range, and those with a low emphasis. Subsequently, the financial performance (ROA and ROE) of the banks in the high emphasis group was compared with those in the low-emphasis group.
The results showed that an emphasis on expense discipline was clearly the best critical success factor at explaining the difference between the financial performances of higher and lower-scoring community banks. In banks with the highest average ROA and ROE, the management focused on cost control throughout the institutions. They emphasized the use of formal surveys to compare their banks’ costs with those of other institutions. Typically, these surveys are focused on human-resource issues and involve things like staffing levels, benefit expenses and the use of part-time employees. These high-performance banks sought to reduce transaction costs by creating and promoting Internet banking (lower cost than the same activity at a teller window) and by encouraging the use of debit cards (lower cost than check processing). At the same time, they closely monitored teller productivity, which likely needed adjusting as the mix of work in the branch changed.
These banks reported putting more emphasis on automated credit scoring models to reduce the costs of making routine decisions such as auto loans and credit card applications. Automated credit-scoring involves less human input and, thereby, lowers the unit cost of making some credit decisions. They closely monitored the banks’ efficiency ratios and worked diligently to obtain accurate transfer pricing data so costs could be properly allocated among the various units.
The survey results indicate that when it comes to getting serious about cost control, no service, product or supply was exempt from scrutiny. Banks with higher financial performance had a strong emphasis on keeping down the costs of routine supplies. Attention to mundane items such as paper, envelopes, printer cartridges and postage fall into this category. Also, items like maintenance, furniture and equipment, and advertising expenses often appear in this category.
The higher-performing banks reported they outsourced nearly everything that could be outsourced to keep down costs. Community banks clearly don’t have the economies of scale to support services such as brokerage transactions, credit cards or insurance; so, typically, they are outsourced.
Community banks really focused on outsourcing have even outsourced things like internal audit and compliance.
The high-performance banks also focused on the use of deposits for funding. Core deposits are typically not as rate-sensitive as other funding sources and are a real competitive advantage to a well-located community bank.
It is important to remember that expense control is a process, not an event. The process is deceptively simple with the devil being in the implementation. Start by getting widespread participation in the process to improve communication, motivation and execution. Develop a profound knowledge about the bank’s cost structure. A cost can’t be reduced if it hasn’t been identified. Don’t over analyze; focus on the costs you can really do something about. Identify the key cost drivers and incorporate them into your efforts.
Constantly look for technologies that can automate service delivery and encourage employees to innovate. Everyone in the bank knows expenses that can be reduced, so give them the opportunity to make cost-saving suggestions and then openly praise them for their efforts. VB
D. Robley Wood, Jr., and Glenn H. Gilbreath are professors of management at the Virginia Commonwealth University School of Business.
Reprinted with permission from the authors.
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