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Banks continue to struggle with cost containment

There is an alarming trend amongst global banking institutions in that they remain reactive in addressing existing costs, the result of which has been an increase in staff cuts in a bid to solve the situation. This is however a quick fix that will not solve a deeper problem.

“The economic crisis brought to light a number of hidden challenges in the global banking fraternity and a significant trend has emerged amongst local banks, one of which has been the recording, of significantly high cost-to-income ratios,” says Francois Beyleveld, Principal Consultant for Performance Management at SAS Institute.

In light of this South African financial institutions have taken an aggressive stance on reducing overheads and are currently looking at the reduction of head counts to help bring down costs, fatten the bottom line and contain spiralling costs.

Let’s take a look at Bank A as an example, where cost-to-income ratio has increased to 56.2% while operating expenses grew by only 15%.  These figures include a 19% increase in information technology costs and expenditure from the previous year, with an increase in staff costs, the largest component of its overall costs, of 16%,” states Beyleveld.

He cites another example, that of Bank B, where its cost-to-income ratio was fast climbing, from 52,4% during 2008 and 2009 to a worrying 61,7% in the year to end 2010.  Reasons for this may be pinned on demands placed on banks by the National Credit Act, as well as sustained lower interest rates and sustained weak demand for financial services.

“But there is an exception and from our analysis this appears to be Bank C that has managed to contain its costs,” he states.  “While this Bank also went through the process of reducing head-count, it conversely managed to slash operating expenses by 13% over the past year, an achievement that few of its peers have managed to emulate.”

Cost-to-income ratio shows what percentage of a bank’s income is spent on operating expenditure or opex. This is particularly relevant at a time when opex is being crunched in favour of capex or capital expenditure. If you analyse the figures, since the beginning of 2009 costs have been climbing quicker than actual income.  That said, a factor to consider is that on average, the cost of people on the Income Statement of a bank on average account for around 60% of the total expenses of the business.

“Ongoing staff cuts shows that banks are analysing expenditure in the wrong places and by cutting back on staff they are merely applying Elastoplasts to the symptoms,” says Beyleveld.  “From what we can see the real issue is that cumbersome and unwieldy processes is affecting the bottom line and many of them currently don’t have a real view of the actual costs associated with their processes.”

Beyleveld believes that banks need to ask themselves: do they understand the true cost of each product for any market segment? Can they effectively allocate the exact or accurate costs to each product, segment or channel?  Banks cannot allocate costs down to a product, segment or channel level as it can be very complex to allocate. Cutting staff quotas may not always be the right approach if the banks have not done a detailed analysis on the aforementioned areas.

“Looking back to the early 1990’s and 2000, banks had an excellent handle on the costs per process and used this information when making pricing policy decisions.  Consequently the time of blaming the recession and local and global regulatory policies, for ill managed expenses are over,” he adds. “The facts are that year-on-year revenues are growing at a snail’s pace while expenses are growing by around 13% based on current market trends.”

In his opinion they first have to start identifying problems in processes, capacity and support costs, and only then can they allocate costs accurately.  After this they can ask themselves the question – should I cut staff? They must analyse which products, markets and segments are profitable or non-profitable – then only can decisions be made about rationalisation. Cost structures must also support pricing models and future decisions regarding new products and services being offered must be made on these.

“As previously mentioned traditionally as a rule of thumb staff expenses in a bank equate to about 60% of overall operating expenses. It is the remaining 40%, of which IT and communication expenses are the biggest contributors, that affect the viability or merit of the product. Most banks do not have a real understanding of how its IT cost expenditure contributes towards each product,” says Beyleveld.

“A detailed understanding and a “what-if” cause-and-effect analysis of actions on the processes are critical and banks need to effectively investigate what works, what the true costs of products are, as well as their ability to price the products correctly according to the true costs without unnecessarily growing capacity. There is simply no point in constantly trying to be innovative, if this very innovation is the reason cost-to-income ratio’s continue to spiral out of control,” he ends.

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