The findings of the recently completed Nolan Annual Efficiency Ratio Performance Study reveal what we have been seeing in the industry. The pressure on revenue is making itself felt in both the bank operating ratios and in the stock market. The Dow Jones U.S. bank index is down over 13 percent in 2008 as of this writing, following a 22 percent decline from 2006 to 2007. There is a direct correlation between a bank’s efficiency ratio and its price/book, as indicated in an earlier Nolan study. We know that the emotions of the marketplace will influence entire sectors, but that “all ships do not fall and rise with the tide” equally.

The Nolan annual study focuses on 10 major lines of business, 83 subcategories, and 1,200 performance ratios. Four of the lines of business (administrative, commercial banking, retail banking, and credit) tell the tale for 2007–2008.

At the top line, or total administrative level, there is a significant gap between the benchmark banks (the top quartile) and the average banks who participated (mean average). The average bank spent 21.07 percent of its operating costs on administrative functions (such as information technology, human relations, accounting and finance, audit, investments, compliance, security, marketing, investor relations, facilities and properties, purchasing, CEO, and corporate staff). By contrast, benchmark banks spent at a rate of 14.53 percent, for a bottom-line gap of $3.25 million for each billion in assets on average. It is significant because acquiring banks often view the administrative costs as redundant and consider them to be part of the acquisition funding. The key areas where the gaps were significant this year were marketing, human resources, facilities, information technology, investments, CEO, and corporate staff.

Commercial banking is one line of business that showed improvement year over year, with a steady decrease in both the benchmark and average banks. The benchmark banks declined from 15.71 percent in 2005 to 7.48 percent in 2007, while the average banks declined from 27.53 percent in 2005 to 20.75 percent in 2007. The gap for 2007—a difference in performance of 177 percent—and the resulting opportunity are significant. The major areas for improvement in commercial banking include middle market, lease financing, business banking, and cash management.

In retail banking, there is one primary area where the benchmark banks have a significant lead over the average banks. The platform area reports an efficiency ratio of 18.32 percent for the benchmark banks, compared to 28.24 percent for the average banks. A contributing factor is the reported productivity, which shows that the number of new accounts per platform employee is 508 annually for the benchmark banks vs. 399 for the average banks. Other areas that show some potential are deposit operations and teller operations.

Credit operations also hold a potential for improvement: benchmark banks reported an expense per commercial, consumer, and private banking loan of $50.27, or $1.31 per $1,000 of loans. For the average banks, the same expense was $83.44, or $2.38 per $1,000. The new account costs hold an even higher gap, with a cost per $1,000 of new loans for benchmark banks of $2.59 compared to the average bank’s cost of $8.88.

Macro results reported in the Nolan annual study give us pointers that we can share in our newsletter, but, given differing strategies and variances in local markets, our specific guidance for participants provides those banks the greatest opportunity for improvement. We invite you to participate in our next study. ▪