Banks’ cost-to-income ratios have risen since the pandemic, reversing a downward trend.
As banks renew their cost optimization efforts, employee productivity is a key battleground. In this report we discuss the performance of cost-efficient banks, and the levers available to reduce cost.
Cost transformation has been elevated to a new level since COVID-19. During the pandemic, there was an understandable shift away from cost reduction to supporting financially-stressed customers. Operational costs rose for a number of reasons — such as enabling work from home, as banks funded both telecoms and hardware for employees, while still bearing the fixed costs of often empty or underpopulated branches and offices.
According to the 200 bank executives surveyed in KPMG International’s recent report New cost imperatives in banking, cost management is rated a “top concern”, with 61 percent saying that cost reduction has become a higher strategic priority since the pandemic. Even though two-thirds of respondents set a cost savings target of more than 10 percent of their cost base between 2021–2024, they also conceded that such aims may be hard to achieve; less than half felt their organizations had achieved previous cost goals. To gain a clearer picture of how banks are tackling cost, KPMG carried out in-depth benchmarking of the cost performance of 60 large banks across the world between 2014–2021. We identify the drivers behind their performance, and discuss how banks can improve their productivity and boost their returns.
Given the importance of cost, the banking sector’s pre-COVID performance could be described as moderately successful, with CIR falling from 64.9 percent to 60.8 percent between 2014-2019. Since the pandemic, however, costs have crept up again to 61.6 percent in 2021 — a trend observed across all regions. This primarily reflects higher staff costs (higher volumes of customer enquiries, higher absenteeism), increased technology costs (accelerated digital development, cost of telecoms and hardware to support working from home) and higher levels of loan loss provisioning.
During periods of growth and decline, the ratio between operating costs (non-interest expenses) and income has remained remarkably consistent for our large global sample of banks. Our analysis focuses on net interest income as a good proxy for underlying levels of customer activity. Such a metric is useful given the global trend to reduce or remove fees in retail banking, and because market volatility can otherwise be a big driver of financial markets’ income. With the huge investment in digitization, one might have expected expenses to have become more de-coupled from income, as automated and scalable platforms should deliver relatively stable costs regardless of the number of customers or transactions. So, why are banks struggling to contain costs? .
Although banks have made considerable progress in applying digitization and automation across the value chain, there are ample opportunities to improve cost efficiency through the use of technology. For instance, the technology estate for higher skilled, middle-office teams such as Risk, Finance and HR can often be modernized to lift productivity. KPMG’s New cost imperatives in banking report recommends that a focused cost agenda looks at activity through three key lenses:
Strategy: Defining the long-term vision and plan for the bank; including the markets, products and business models that deliver customer relevance and shareholder value.
Simplicity: Ensuring the bank’s organizational, accountability and governance arrangements enable fast decisionmaking and operational agility, to drive both ‘change the bank’ and ‘run the bank’ cost efficiency.
Engineering: How banks deliver services to their clients, including channels to market, use of technology, and roles and capabilities of people.
Within this approach we’ve identified 12 cost transformation levers. In light of the high people costs associated with banks, employee productivity should be high on the agenda, enabled by technology investment. Areas for improvement include continued operational efficiency through process automation and digitization; efficient, platform-driven distribution models encompassing retail branches, relationship managers, contact centers and digital channels; and data-enabled functional support services such as Risk and Finance across the bank.
Digging deeper, here are some examples of the key levers for achieving lower cost through higher productivity:
Reducing excess management reporting: simplifying decision-making, as well as zero-based design of reporting services, to reduce the burden in terms of granularity, frequency, format and associated discussion meetings for management reporting. This should significantly lift the productivity of the professionals tasked with upwards reporting. Such a move is especially relevant for support functions such as Finance and Risk, who typically face large, onerous reporting requirements.
Automating transformation dashboards: producing real-time dashboards for all transformation projects within the bank, allowing project teams to spend more time on transformation, and less time on status reporting. Given that all initiatives should share common and standard key performance indicators, a dashboard approach can prove both appropriate and efficient.
Optimizing distribution platforms: using customer segmentation, customer journey design and sales and service process digitization to optimize legacy distribution models. Better use of technology creates assisted distribution platforms that make better use of the unique skills of the humans in the field, branches and contact centers. The optimized use of digital channels and self-service frees up frontline staff to focus their efforts on the highest value customers and customer interactions.
Automating and digitizing back-office processes: in many banks there has been a slowing down of results from process efficiency improvements, after early efficiency wins from workflow automation, robotic process automation and digitization. However, in areas such as customer due diligence and credit, many highly manual processes remain, with unnecessary reliance on bank staff for standardized inputs and intervention. In addition, growing use of machine learning and artificial intelligence increases the scope of processes that can be redesigned to lift productivity.
Rationalizing and automating risk controls: reducing manual risk controls by lowering the number of controls and increasing the use of smart technology. As risk professionals are scarce and come at a premium, they should be used by banks where they are most needed and can add greatest value. As many risk controls are standardized and repetitive by nature, human intervention should be optimized.
Simplifying ‘run the bank’ infrastructure: with an aim to reduce IT costs. Standardization of technology estates, and better interoperability of technology components, widens the scope for more efficient (out) sourcing of infrastructure. Similarly the move to cloud reduces the need for on-premise IT infrastructure and associated technology staff.
Although most or all banks are actioning the above levers to some degree, the failure to significantly improve operating costs suggests that more could be done to optimize the impact of transformation initiatives — notably with regard to employee productivity. We propose that banks adopt a three-phase approach for a permanent operational and culture shift towards greater cost efficiency:
Phase 1: Qualify
Faced with a host of cost-reduction initiatives, CFOs need a robust, standardized qualification process that assesses initiatives’ objectives, feasibility and measurable key results. This enables like-for-like comparisons. In particular, transformation business cases need to be outcome-based, with clear efficiency and productivity targets supporting funding requests.
Phase 2: Prioritize
Priority should be given to initiatives that can deliver significant, ongoing cost efficiencies (including staff productivity), are achievable within agreed time frames, and are aligned with strategy. Banks can then compare business cases and prioritize those with the biggest impact. Importantly, initiatives should fit within the change and investment capacity of the bank, as new and in-flight projects compete for scarce transformation capabilities.
Phase 3: Manage
Like a car navigation system that re-routes when traffic occurs, the ability to alter direction is essential, to overcome barriers and adapt to changing circumstances. This transformation agility needs to be underpinned by accurate and real-time performance reporting. Only through a genuine understanding of the budget, performance and delivery status of their transformation initiatives can banks manage these programs in a timely fashion.
