How Banks Achieve High Performance: Strategies and Metrics

Introduction

Following a wave of consolidations and deregulation during the 1990s, the banking industry has become increasingly competitive in recent years. Moreover, innovations in so-called e-banking have created demand for a wider range of banking services available through a number of delivery platforms. Banks can no longer afford to specialize in a narrow range of services, and they have been required to respond to marketplace forces in meaningful and timely ways in order to remain competitive. In this environment, identifying how banks achieve high performance has assumed new relevance and importance. This paper provides a review of relevant peer-reviewed and scholarly literature concerning these issues, followed by a summary of the research and its key findings.

Defining High Performance in Banking

Although definitions vary, Grasing suggests that performance is generally a measure of how successfully banks manage and structure time so that the impact of the banking work process has its most significant effects. More specific features of high-performance banks were examined in a study by DePrince, Ford, and Strickland, who cite the results of a series of seminal articles examining Federal Deposit Insurance Corporation (FDIC) call report data to identify the factors that characterize high-performance banks. This analysis was important, DePrince and his associates suggest, because "Everyone in the business knows banking has changed dramatically over the past 20 years. Size and number of institutions, types of products offered, and technological advances come readily to mind. But what is less well-known is if, and how, the methods have changed for being a high performance bank" (36).

Based on their analysis, DePrince et al. report that high-performance banks typically earned profitability through various channels at higher than industry averages by minimizing unfavorable trade-offs between asset yields and risks — generating increased interest and fee income on loans and investments while experiencing fewer losses on those assets. In addition, high-performance banks eliminated waste at every opportunity and controlled the cost of funds by collecting lower-cost funds compared to their average-performing industry counterparts (DePrince et al. 36).

Other factors that set high-performance banks apart included the ability to minimize personnel expense as well as other overhead costs such as lease and operating expenses (DePrince et al. 36). Rather than simply paying their personnel less, high-performance banks excelled at minimizing human resource costs by achieving more loans and deposits for each full-time employee compared to the industry average (DePrince et al. 36). According to DePrince and his colleagues, "As a result, the full-time high performance bank employees — on average — generated over 90% more net operating income than their less adept peers in other banks" (36).

The final factors identified by DePrince et al. were the ability to generate and retain more earnings than other banks each year and the ability to increase loans, assets, deposits, and equity faster than industry counterparts. This level of agility is essential to achieving high performance following deregulation and increasing competition from non-banking competitors. Suter emphasizes that "The pressure to create new sources of revenue is not merely a result of the fabled shift in consumers' attitudes from a saving to an investing mentality. The advent of commercial paper, money market mutual funds, and securitization have enabled non-bank institutions to progressively steal vital financial assets from banks for the past several decades. Top performing banks are those that have continually reinvented the banking business to boost performance in the face of growing incursions by nonbanks" (36). Following deregulation, Suter suggests that high-performance banks have more actively sought out alternative revenue-generation sources than their lower-performing counterparts. "Many of the top-performing institutions," Suter reports, "have successfully adapted their businesses to take advantage of fee-based sources. Others have adopted lending specialties to fuel asset and interest income growth while increasing efficiency" (36).

Return on Assets and Loan-to-Deposit Ratios

Although a number of metrics can be used to gauge bank performance levels, Spinard and Suter argue that banks' return on average assets ratio has long been considered one of the best single metrics for assessing performance. "Even today," Spinard and Suter add, "return on assets remains an accurate gauge by which to measure industry performance" (35). A study by Pickering found that at year-end 2000, about 3,800 banks in the United States had assets between $50 million and $500 million, and the highest-performing 950 banks in this group had return on assets levels of between 1.64 and 1.67, with an average of 1.65, compared to the industry average of approximately 1.12.

An important point made by Pickering, however, was that each of these high-performing banks competes in a different environment and has identified its own optimum approach to generating higher returns on assets. Pickering advises that "Each bank is in a unique environment that determines that bank's most profitable loan-to-deposit ratio — some environments support a high ratio while others do not. Bankers who try to push their bank's ratios higher than their environment can support will very likely reduce profits. However, bankers who recognize that they have reached their bank's loan-to-deposit 'sweet spot' can then maximize profits by maximizing the effectiveness of their bank's investment portfolio" (89).

Likewise, Hanley, Suter, and Cocheo report that across-the-board comparisons of high-performance banks can be misleading because they may fail to identify all of the factors accounting for their success, given that every bank is unique in terms of its product and services mix and the communities it serves. Hanley and his colleagues emphasize that "While many similarities exist among institutions, the industry is not homogeneous. Banks may differ on product offerings, delivery strategy, and business focus. Rankings showcase competitors that have developed a business formula that maximizes returns, and are an instrument, albeit blunt, for identifying the drivers of today's banks" (37). Similarly, Lenhoff reports that as of year-end 2008, the 400 top banking performers did not achieve their success using the same methods: "Differences in markets," Lenhoff advises, "dictated differences in approaches" (29).

These points are echoed by Donner and Dudley, who suggest that the highest-performing banks are those that have identified the optimal mix of pricing structures and customer services for the markets in which they compete. "High-performing banks have the ability to find the right balance in customer relationships and operations," Donner and Dudley note. "They carefully measure and manage those items which count the most, and effectively combine seat-of-the-pants marketing with customer research and sales databases" (18). Another distinguishing factor was the quality and experience of the leadership team in place (Donner and Dudley 19). "Most notable in these institutions were the CEOs. They were actively involved in all aspects of their businesses and built a team of managers and employees who understood and embraced their corporate vision" (Donner and Dudley 19).

Conclusion

The research showed that the environment in which banks compete today has changed in significant ways, with consolidation and deregulation introducing a number of challenges for banks of all sizes and types to remain competitive. The research also showed that high-performance banks are generally characterized by higher returns on assets compared to the banking industry average, but a number of other features also set them apart. These features included more efficient use of time and resources to generate revenues, higher levels of banking personnel performance, integration of technology where it has the most significant effect on operational efficiency, and an organizational culture that emphasizes profitability and top-level performance.