In my first blog, I defined what an efficiency ratio was and introduced some tools that organizations often use to help improve their overall efficiency. In that same blog, I suggested that we would delve into each of the tools in more detail in future blogs. The tools are often devised as longer-term methods of improving efficiency, and hence the efficiency ratio. But what can you do when you need to reduce expenses in the near-term?
CEOs and other executives often recognize that finding short term solutions to improving efficiency can be good for the bottom line. One way that institutions often do this is to form project teams with the sole purpose of reducing expenses. So, imagine yourself as the person picked to lead this effort in your organization. Where do you begin?
You need to have a deep understanding of your expense base within the organization. What comprises the expenses of the organization, and most importantly for this kind of exercise, what are the non-interest expenses of the bank? In most financial institutions today, employee expense comprises 40% to 60% or more of non-interest expense of the bank. So, do you suggest then that you should simply lay off 10% of the staff? That will certainly help the organization meet the expense reduction goals, but it may not be the best solution to this issue. Layoffs are often poorly executed. The wrong people are let go, or organizations do not really grasp the importance of certain individuals or departments and the impact they have to the success of the business. As a result, staff levels tend to creep back up in a relatively short period of time. There are solutions for right-sizing the organization.
In my experience with operational efficiency projects, staff layoffs are not what the CEO has in mind. Instead, the CEO wants you to dig into the other 50% of non-interest expenses to squeeze out some money quickly. Still, the nagging question is where to begin? To do this exercise successfully, you will need to have a detailed breakdown of cost items from your accounting group. These are found on the general ledger. So when you are asked to lead this effort, be sure to request someone from the accounting group to be on your team as their expertise in diving through the general ledger will be essential. The numbers should be rolled up to the enterprise level and broken down into some different categories including: office supplies, facilities maintenance, benefits, data processing, telephone, postage, courier, dues and subscriptions, hardware and software, ATM, armored courier, service charges, and etc.
The next step is to break each of these expenses down into their component pieces by cost center and individual categories. For example, at one regional bank where I was employed in the early 90’s, I was on a committee similar to the one I mentioned, we broke down the facilities maintenance expense. With more than 150 branches and several large office buildings, we expected this expenditure to be in the millions. However, when we broke it down into its component parts, we discovered something interesting. We were spending nearly $2 million annually to maintain live plants. Most of the money used to accomplish this was being spent with one local contractor who specialized in tending live plants. Of course, our next question was could we ask our own employees to do this on their own? In an office tower with common areas, this might be a bit of a stretch, but at our branches and in individual departments, we believed that this could be handled by staff. We logged it as an idea and in the end, were able to save more than $1.5 million dollars just on this expense item.
In the supplies number, we discovered that our purchasing group bought 100 million branded envelopes, because it reduced their cost per item by a couple of pennies per envelope. This cost around 15 million annually. We also discovered that Marketing changed our logos on average every 5 years. This meant we had to destroy these supply items with the old logos, in turn, wasting money. The net differential of buying a one or two year supply of envelopes versus destroying millions at a time was a savings of about $50,000 annually. We found dozens of instances where we could save between $10,000 and $50,000 annually by changing how we purchased supplies. Individually, some of these seemed low, but in aggregate, they added up.
I could probably fill a number of pages about finding different expense reduction ideas at financial institutions where I have either worked or consulted. In most cases, these reductions were the result of using the general ledger as the tool to understand the organization’s expenses. Moving from the high level to the detailed breakdown can reveal anomalies that lead you to the underlying cause of the expense. The general ledger that houses all this wonderful information about expenses is the best place to start your search.
The two examples given were in facilities and supplies expense categories. However, these are not the only two places that you can find expense items. Some other places that I have found excessive expenses include: telecommunications, subscriptions (how many magazine subscriptions can one financial institution have), travel, education, coffee, food services, couriers, postage, janitorial services, and security monitoring.
Needless to say, we could not have broken down the expenses and dug into the root cause of what created the expense in the first place without starting with the general ledger. For smaller financial institutions, the million dollar items might not be there, but there are always ways to reduce expenses if you take the time to dig into the general ledger. I learned early on in my banking career that no expense reduction item is ever too small. In addition, I learned that it is often difficult to find the million dollar items, but there pockets of small dollar reductions available if you look for them. Remember, every dollar of expense reduction helps reduce the efficiency ratio reflecting a stronger, more efficient financial institution.
