roductivity, efficiency, and costs are never too far from bank executives’ minds. In previous waves of efficiency drives, banks have succeeded in reducing costs, though the extent of these achievements has varied—from about 3 to 5 percent at most banks to as much as 10 percent for the most successful ones. However, most of these gains are short lived as other priorities and demands erode progress, leading costs to creep up again. Given macroeconomic and geopolitical uncertainties, it behooves banks to keep a close eye on efficiency to achieve ROE of 10.0 percent or more and ROA of 1.5 percent or higher. Boosting efficiency has the additional benefit of creating surplus cash to invest in building capabilities in gen AI, tech modernization, data, cybersecurity, and more.
For a bank, improving productivity means reducing the unit quantity of work required. This measurement and the related costs for banking products have increased for the past decade or so because of increased complexity and process inefficiencies. For example, the average cost to originate a mortgage has risen 8 percent a year, from about $5,100 in 2012 to about $11,600 in 2023.1 Beyond inflationary effects, this steady rise was driven by the increasing work that needs to go into a mortgage, including risk and compliance factors. Streamlining and simplifying the process will not only reduce costs for banks but also boost customer satisfaction by minimizing errors and accelerating processing times. Interestingly, the most efficient mortgage originators made mortgages at a cost of roughly $6,900 in 2023, about 60 percent of the average cost.
Productivity challenges
Banks are acutely aware of their stubborn costs but often struggle to effectively mitigate them due to myriad challenges, including complex operating models, competing risk management initiatives, and patchworks of legacy systems and processes inherited from M&A deals. These competing priorities have forced banks to focus largely on near-term efficiency solutions, which don’t address the core issues. Not surprisingly, banks find themselves perpetually treating symptoms rather than curing the underlying problems. Banks recognize that cost efficiency is critical, launching efficiency programs every two to three years, on average. However, these efforts typically fall short of transformative impact, often focusing on quick adjustments rather than on fundamentally reducing demand or simplifying the operating model.
Simplification
This is the moment to ruthlessly apply Occam’s razor, the principle that the simplest solution tends to be the best. To simplify, banks can scrutinize their business the way an investor would, calculating the ROI for various functions, processes, and segments.
Scale
Achieving the right scale is essential, especially in the challenging business environment banks face. To remain competitive, a bank must be strong as well as nimble, agile, and adaptive. Over time, regulatory requirements, compliance, technology, and risk management have added significant burdens. To handle these, institutions may choose to increase their scale to sustain the additional load.
Productivity
Entropy increases over time, with systems naturally drifting toward chaos unless corrected. How, then, has it been possible for US businesses in general to boost productivity while the banking sector has stagnated in this respect?
Improving productivity comes down to factors including technological advancements, globalization, skill enhancement, economic policies, broader consumption patterns, and process enhancements. The banking sector has benefited from these factors. Why, then, does the full potential of banking productivity remain elusive?
Read the article by Akshay Kapoor and Asheet Mehta / McKinsey & Company
