Fixing the Efficiency Ratio for Community Banks
We have all heard the old adage, “If it ain’t broke, don’t fix it.” So, how do you know it ain’t broke?
There are many measures of success in banking: revenue growth, profitability, market share, degree of personal satisfaction, and even the amount of impact you and/or your company are having on society as a whole. All of these measures are relevant. However, here I will define success as operating at optimal efficiency – generating the greatest amount of revenue possible for each unit of cost while maintaining the highest level of client and employee loyalty – which is the ultimate determinate of being broken or not.
By these standards, many community banks today are broken. Banks within the asset band of $1 billion to $10 billion reported an increase in their efficiency ratio (ER) from 58% at December 2007 to 63% last December, according to data from Spotlight Financial Inc.’s Bank Trends. For those within the asset range of $1 billion to $5 billion, the ER climbed from 58% to 66% during the period.
It appears as though many institutions were running scared in the wake of the financial crisis by wildly cutting staff without considering the talent they were losing; increasing fees to customers without recognizing the attrition factor and generally destroying employee morale, along with their company culture and vision. The road to recovery, then, will entail more than just cleaning the balance sheet – it will include fixing what was destroyed in the wake of the storm.
Implementing a High Efficiency Model (HEM) is the primary step in lowering the ER and establishing a solid foundation to support an organization’s long-term health and sustainability. As stated in a recent Deloitte report, “one of the more obvious opportunities for improvement in the current environment is an enhanced focus on efficiency. It may be one of the few margin generators available as topline challenges continue to increase.”
So how do you implement a HEM? The first step is changing the corporate mind set from being “client-centered” to being “employee-centered.” If an organization promotes employee exceptionalism and wins employee loyalty first, client loyalty will follow. Exceptional products and processes flow from the ideas and efforts of exceptional people operating in a trusted environment. To accomplish this, institutions will need to act on the following:
Personal Efficiency Ratio (PER). What is the PER of your company’s top executives, mid-level managers and frontline employees? How much of one hour of energy spent results in a profit or benefit for their life and the life of your company?
PER can be calculated in three steps. First, divide the employee’s average total monthly revenue generated by the number of hours (160) in the month. Then, divide revenue generated from an external event by labor cost + actual event expense. Lastly, add the time spent (one hour = 0.1) on Learning Events (LE) that have the potential to increase the propensity for success in an individual. Add the three components together to get the PER. Each job family in the institution would have a different target PER based on desired results, or profits. A low PER in any one month would not necessarily be cause for alarm but diminishing results over a six-to-nine month time span clearly demonstrates a need for concern.
Trust Culture. How do you measure trust? Knowing and addressing internal/external trust barriers is a must. Internal/external referrals and repeat business are two sure ways to determine if your employees are “trusted.”
To further embed the concept of a Trust Culture, establish a Personal Trust Ratio (PTR), a specified number of referrals per month combined with a quantification of repeat business per month expressed as a ratio, which can be discussed in weekly reporting sessions. How nice to hear, “You have the highest PTR in the company!” There is an immediate sense of pride in the accomplishment. Highlight it and reward it.
Unexpected Events Readiness. Unexpected events can include a new competitor offering, a loss of a key employee or a liquidity shortfall due to new regulatory demands. To avoid scrambling at the last minute, designate a project team or individual to constantly review market demands and competitor activity, implement an employee mentoring and management succession plan and establish benchmarks and buffers to protect your balance sheet. For example, a company should benchmark their cash-to-revenue, cash-to-assets and cash-to-liabilities ratios higher than the median ratios of comparison companies to buffer against any unforeseen events.
Excellence in Process Management. Ensuring optimal efficiency in process management is paramount in lowering the ER and incorporates two main areas: human capital and the decision-making process.
- Human Capital: Mandate time limits on the hiring process and include cognitive testing for all key individuals. Research shows that cognitive aptitude tests are the best predictor of job success – twice as predictive as job interviews, three times as predictive as experience and four times as predictive as educational levels. Implement an efficient onboarding process for employees, which will result in greater cost savings and increased workforce productivity. Begin onboarding a week prior to start date and continue for three to four weeks. Later, mandate weekly Learning Events and knowledge-sharing. Establish employee certification requirements to build a visible pool of highly skilled workers and lastly, embrace a culture that nurtures and respects employees and provides ample opportunities for training and development.
- Decision making and the distribution of power: How a company decides who is authorized to make various types of decisions can have a profound effect on its business, both in terms of everyday effectiveness and on the ultimate bottom line. A “top-heavy” distribution of power, for example, can limit the ability of frontline managers to be productive and make decisions on behalf of customers. A four-step plan for optimizing decision-making efficiency would include routine reviews of how decision authority is distributed; a conscious effort to avoid too much centralization; a clear and unequivocal assignment of decision rights; and a refusal to confuse a particular outcome with the process itself.
So how do you win? Resolve to change. If your definition of success does not align with the goal we established above – generating the greatest amount of revenue possible for each unit of cost while maintaining the highest level of client and employee loyalty – then, change is in order.