1. Focus on marginal costs
Why do banks that have long focused on cost reduction still invest heavily in nonstrategic areas, such as know-your-customer (KYC), legal and financial crime?
For most banks, it’s because cost indicators are set against budget outlays; and cost reduction targets are set against parts of the business with the biggest budgets, rather than being focused on productivity. This means banks continue to own these non-core and non-value-adding activities, which increase the overall complexity of the organization. In essence, banks typically focus on reducing 4% of 50% of the cost base, rather than 90% of 4% of the cost base.
Instead, banks must build a clear view of what’s value accretive, and what isn’t, and the basis for that should not just be the budget required for the activity. Simply because an activity is less costly does not mean it creates more value. For banks to identify the right value accretive activities, they need to strike a balance between rationalizing the denominator (input cost) and optimizing the numerator (output value).
The core elements of driving a value focus will include defining the right metrics, developing measurement frameworks to identify and assess the potential value and cost of opportunities, and establishing strategies to deliver on opportunities.
But, doing this can be challenging. While a benefits case may seem clear, the implicit impact on the organization may not be, due to a lack of adequate metrics and frameworks. Building this understanding requires banks to consider all dimensions together, including financial resources, physical assets, data and people. It requires more granular data on additional costs (both direct and indirect) attributed to the growth opportunity. It also requires an understanding of the existing operations of the banks and additional complexity that an opportunity or investment could bring.
Banks that do this well make it an ongoing priority. One leading Taiwanese bank has set up a designated unit focused on continually re-examining operations to find opportunities to improve and streamline.
2. Reassess non-strategic activities
Outperformers rapidly reduce costs to create capacity to innovate, even in challenging market conditions. Many do this through outsourcing, use of an industry utility or managed services, which can be a more effective and value-adding way to run non-core but critical activities. Another option is moving non-value adding products and services to third-party vendors or automating them, cutting unprofitable products or collaborating with specialist providers to deliver those services that are critical to your client, but which you can’t deliver profitably.
For example, investment banking divisions can free up capital by automating manual processes within post-trade, reducing siloed collateral management, and leveraging the right partners to improve strong data quality and reduce inconsistent trade representations and overall business risk.