When bankers search for ways to improve operating efficiency, often those efforts are directed at increasing revenue or redesigning the major new business and servicing processes that generate revenue. One often overlooked category that in many ways represents the greatest risk to the bank is the administrative costs. These costs vary widely from bank to bank. The underlying risk is that, in a climate of merger and acquisition, administrative costs are largely redundant. This surplus presents an acquiring bank with funding for a purchase.

When Nolan defines the scope of administrative costs for a bank, we include CEO and corporate staff, Finance, Marketing, Investments, Human Resources, Information Technology, Audit, Facilities, Compliance, Legal, Investor Relations, Security, Purchasing, and Risk Management. The difficulty many institutions face with analyzing the economic effectiveness of these functions is that there are very few reliable metrics offered to calculate the value or a reasonable level of expense. One source for that information is Nolan’s annual Bank Performance Study.

Metrics provide an important measure of efficiency though unfortunately they are sometimes ignored or explained away. For example, with Marketing, the choice can be made to look at the cost over total bank revenue or the cost as a percentage of new business. We can assess marketing effectiveness in our most recent bank performance study by examining the gap between the top quartile (the benchmark banks) and the average banks. In top-performing banks, the marketing cost per $1,000 of new deposits is $59 vs. $125 for the average banks. We actually see some individual banks with extreme cost of more than 5% of their operating cost. The gap of 111% is significant enough on its own, but how do executives explain the gap? Some may explain that they opened new branches and had higher image advertising costs to introduce the bank to the new community. Others may cite a new branding program as a one-time event. It is interesting to note that, when these arguments are advanced, it is rarely asked whether the top-quartile banks also had new openings and rebranding programs or if the costs incurred by the average banks translated to new customers and accounts. It’s important to understand the true reasons for such gaps. It’s more important to take action to close the gaps.

With Information Technology costs, the gap overall between top-quartile and average banks for total spend to total bank revenue is 65% with 2.5% for top banks and 4.2% for average. Even more alarming is that we see individual banks over 5% where our research shows that this alone has a direct correlation to lower bank performance. The discussions around the gaps often focus on outsourced vs. internal costs, new platform costs, high network costs, extensive projects to integrate systems that will lead to greater effectiveness down the line, and “building an infrastructure for a bank twice our size” to support aggressive growth plans. All of these arguments seem reasonable, but the question of when cost will be brought in line is rarely addressed.

When examining total administrative costs, Nolan’s BPS study shows that the gap between the top-performing banks and the average has increased in the last two years from 35% to 49%. The most current metrics are a range of 11% of cost to total revenue for the top performing banks and 16.5% for the average banks. We know from firsthand experience that it is more difficult for many banks to examine administrative costs than to examine line- of-business costs. But you must discern what is hidden from view versus what is simply a cost of doing business. The focus then reverts to the visible customer contact functions. Nolan has those essential metrics and we believe that the next wave of merger and acquisition activity will focus on these costs. The winners will be the banks that drive improvement by paying close attention to the metrics.