Sample this: the Operating cost (OpEx) to Income ratio of a typical private bank in steady state has remained in the 45-50% range for many years. Ditto with the OpEx to average assets which is 1.9-2%. The differences primarily arise from the composition of the loan book – more the retail, the costlier it is; more the term loans, less costly it is.

If banks could push the cost-to-income ratios down to become 10% more efficient (say), the ~0.2% pp gain to return on assets (RoA) will be massive in an environment of RoAs languishing at around 1% due to poor asset quality.

This has happened, if at all, incoherently and episodically, despite massive investments in technology, and its concomitant realized impact on customer transactions shifting to non-branch channels. This is a matter of concern, particularly when juxtaposed with the fact that ~20% of banks’ assets by regulation (and in practice, higher) need to be in treasury that consumes relatively little OpEx compared to taking deposits and lending.

Here are the market dynamics and industry practices leading to this state:

  1. The single largest opex item is branches (read employees). And banks are still adding a significant number of branches every quarter. Smaller banks are loading their network even more. New branches are continuing to add a “negative carry” (drag on profitability) until they mature, and some never do.
  2. The above arises primarily from a quandary on liabilities: CASA (Current and Savings Accounts) are still the cornerstone of a bank’s source of funds, the most profitable “product” for a bank, but the most opex-intensive. This is getting even more OpEx-intensive as competition is increasing and customer needs are becoming more sophisticated. Even since the Savings Account deregulation a few years back, very few banks have actually increased SA rates – in fact some have reduced them recently – but the strain is indirectly reflecting in higher OpEx to sustain these accounts.
  3. The credit process is getting lengthier than before. For example, a bureau report, and sometimes a credit score, is an absolute must now. Even recoveries have been hemmed in with regulations to contain reputational risks to the banking system.
  4. The focus has now turned to bringing in more of the middle- and bottom-of-the-pyramid customers as the top has been largely scraped. These new customers are harder to acquire and service, and generate lower business.
  5. Commission rates on fee products such as mutual funds, insurance and cash management have progressively come down, leading to higher Cost-to-income ratio.

Here are some of the ways of alleviating the problem. This is not to suggest that OpEx ratios can continuously decline – they will not. But they can be controlled. Neither do we suggest that these are all new – banks have been adopting them in some form. The path to cost containment is more of technology, not less, and its enhanced use.

  1. The frenzy of branch additions needs to slow down. This may be easier said than done, as the historical correlation between opening branches and garnering CASA is still alluring. But that is not necessarily true any longer. The scenarios of a 3,000-branch bank adding 100-150 branches a quarter, or a small bank with 200 branches in 80 years doubling its network in two years, is simply not sustainable.
  2. The key route to the above is increased use of suitably tech- assisted and augmented ‘banking outlets’. In its earlier avatar, ‘banking correspondents’ were not particularly successful, but the rising number of banking outlets in the last year shows that banks are finding these useful.
  3. Servicing costs of a savings account are still high, three key reasons being the volume of cheque clearing, low-usage or inactive accounts, and monthly statements. The drive to reduce cheques, conversion of payments to digital or mobile need to intensify and broaden. Today, these may appear to be already on but are primarily urban-centric. Monthly statements can largely be converted to quarterly in case of physical, or better still, email statements in many cases. On inactive or low-use accounts, the attempt should be to use data analytics to activate them rather than shut them down (which is tedious).
  4. The blunt instrument of penalties for cash withdrawal at branches needs to be used with greater force in zones with good ATM presence. ATM addition has slowed down over the last 2 years, counter-intuitively.
  5. Branch profitability analysis of Tier 3 and Tier 4 branches should be conducted rigorously to re-orient for profitability. This almost needs a retail-like ‘Sales-per-Square-foot enhancement’ kind of an approach. This is a subject by itself and beyond the scope of this article, but suffices to state that adequate granularity is warranted. For example (real life case), customers that normally use a bicycle to commute to the branch require a different approach (literally and figuratively!) as against those who use a tractor.

We would love to hear your thoughts on the above. At Praxis, we are leading the drive towards higher productivity – call us if you want to discuss more.