How banks are driving new cost reduction strategies
by Tyler Higgins and Chris McGeeMr. Higgins is a Managing Director and Strategic Cost Reduction Practice Lead, and Chris McGee is a Managing Director and Financial Services Practice Lead at AArete, a global management and technology consulting firm. They can be reached respectively at email@example.com and firstname.lastname@example.org.
Investment bank revenues are plummeting, commercial bank earnings have experienced mixed results, recession is looming, and market volatility continues to be turbulent – and the result for financial services has been an increase in layoffs and bonus cuts.
This initial response has been focused on quickly rightsizing the labor force, but more broadly for banks who continue to face a tight labor market with an ongoing “war for talent,” there are plenty of alternative strategies to deploy beyond cutting the workforce. As banks have seen headwinds impact their expense lines, the time is now to drive expense reduction through nimble and innovative strategies across non-labor spending. The current mindset needs to change and the banks that respond will turn the volatility into a competitive advantage by both retaining critical talent and improving profitability.
How Did We Get Here?
The roller coaster atmosphere that was established from 2020 through 2022 impacted all people and all businesses – the financial services industry was no different. Just as other sectors focused on growth amidst a tight and competitive labor market, financial institutions had to spend and hire aggressively across their workforce. 2021 resulted in a thriving sector supported by an economy that set the stage for growth. Consumers were flush with capital. Overall funding was cheap to access. Corporate deal making drove substantial earnings. M&A activities had rebounded in 2021 after a substantial decline in 2020. The business landscape was thriving, but that now has become short lived.
Once interest rates began to climb and the economy started to flip, the business landscape rapidly changed. Deal-making dried up putting downward pressure on earnings. Low-cost borrowing was gone. Higher operating costs – some inflationary driven – had arrived. Organizations that had grown an inflated workforce expecting a boom to continue had flipped to a more gloom environment.
Commercial banks have increased their loan loss reserves amidst mounting economic uncertainty, mortgage originations and fee income is down significantly from last year, and banks are forecasting a decrease in lending profit and expecting depositors to start more actively searching for higher savings rates. This rapidly changing environment has exposed potential weaknesses in growth strategies across the sector and now has positioned banks to ask themselves, “What more can we do?” over these next 12 months.
What Can Be Done?
While the first wave of cuts has been on labor and a decrease in bonuses, as it is most of the time, banks should shift to other areas of spending. The landscape has positioned banks to respond with focused cost strategies that drive not only immediate profit but also long-term agility. The majority of banks have set ambitious savings goals in years past and this is no different in 2023. However, the struggles of past initiatives to fully realize rapid savings opportunities against lofty corporate goals can no longer happen. 2023 is setting up for a year where banks must fully realize results. The opportunity is here to deliver more ambitious savings through operational strategies including:
- Empowered decision makers
- Centralized management of third-party spending
- Improved alignment between Business and Shared Services
- Rationalization and redirection of critical activities across existing teams
- Establishment of unified corporate goals
As banks deploy these operational strategies, there are specific actions that these teams need to execute and deliver upon, which are areas that are ripe with opportunity. For banks, the challenges of successful cost savings execution have only been compounded recently given the declining growth trends within the sector. For example, banks have focused on significant acquisitions to expand their capabilities. The negative outcome of this growth has been a complex business model that creates natural waste, redundancy, and lack of central control.
Banks can deliver expense value creation through comprehensive strategies including:
- A Shift from Risk to Right-Sizing: Central procurement teams have historically been focused on risk management, but a shift needs to happen. Teams need to right-size contracts, focus on driving cost out of every contract, and align with the business on value creation activities.
- Hyper-Focused Category Management: The complexity of a bank has created duplicative functions and third-party vendors engaging across multiple business units. Banks need to empower central resources to deliver cross-organizational savings strategies and drive category management with their key business partners.
- Post-Synergy Value Creation: M&A activity within the banking sector has led to tremendous growth, but organizations have not fully realized synergies from this activity. Now is the time to revisit acquisitions and ensure that full synergies are still being realized and address missed opportunities that need to be realized soon.
- Spend Criticality Evaluations: Banking is changing and expense structures are changing as well. Banks have an opportunity to launch spend criticality evaluations to determine where there is waste and/or rationalization opportunities.
The Time to Act is Now
The convergence of rising interest rates, inflation, and uncertainty has set the stage for banks to win or lose in the next couple of years. Some have made their first response – layoffs and bonus cuts. Now is the time to make the second – a hyper-focused effort to manage and reduce non-labor related costs. The uncertainty of the market is requiring more nimble and agile organizations. With a focused effort to remove costs from the expense line, banks can rein in spending, retain critical talent within their workforce, increase reserves to prepare for a potential recession, and navigate the market to be well positioned in the future.