Investigative Study on What Makes One Bank More Efficient
Than Another
FIN 5330
The purpose of this paper is to analyze what makes one bank more efficient than another bank by
examining various characteristics that impact a bank’s efficiency. In the following analysis we
have found the following characteristics impact a banks’ efficiency: ownership and management
characteristics, competition, stability, technology, bank consolidation, leadership style and
employee job satisfaction. A more efficient bank will have: a board of directors that is actively
involved and a daily managing officer who has stake in the company or proper incentives to run
it; a competitive advantage, therefore reallocating more profit to the bank and remaining stable
in terms of management; a strategy to adapt quickly to new technology and capitalize on it; a
strong leadership style to increase employee satisfaction; a collection of data that drives
innovation and a strong customer relations team.
Ownership and Management Characteristics
One of the biggest problems for any bank in this area is agency problems. To run
efficiently, banks must have management be relatively aligned with shareholder values. One
factor affecting this relationship is the board of directors. The board of directors can have an
impact on the efficiency of a bank because they are responsible for hiring and overseeing
management, setting major policies and objectives, and a part of major decisions in the
operations of the bank. In a case study conducted by Spong et al. (1995), they found the
following:
“Efficient banks are characterized by boards that are more actively involved in
their banks—an involvement through such means as strong ownership position,
other insider ties, and regular attendance at board meetings. Efficient banks have
also been willing to pay higher fees for directors and, on the basis of net worth
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figures, seem to have succeeded in attracting a more successful group of
directors” (p. 11).
Table 1 shows some of the various
characteristics that define board of
directors in most efficient vs. least efficient
banks. It can be seen in efficient banks the
board of directors attendance rate was
2.1% higher than those in less efficient
banks. The board of directors in the most
efficient banks also had more meetings per
year at 11.6 vs. 10.6; and finally in the
most efficient banks, the board of directors
were valued much higher with a net worth
of $1,317,000, about 63% higher
compared to the board of directors in the least efficient banks. The study also observed the
impact of how the size of the bank can affect efficiency. It is not to say that larger banks are more
efficient than smaller banks but the relationship between ownership and management can vary
widely depending on the size of the institution.
Depending on the size of the bank, it may have many stockholders or very few
stockholders with either a dominant or non-dominant ownership of those shares. In result, the
severity of agency problems and control conflicts can range widely within a particular bank.
While agency problems are practically unavoidable in any corporation, it can be concluded that
more efficient banks have minimized agency conflicts. One job in particular can play a big role
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in alleviating or creating more tension in agency problems, and that is the role of the daily
managing officer (DMO) (Spong et al., 1995). The daily managing officer is responsible for
overseeing and running the day-to-day operations of the bank, as well as making decisions that
arise in daily operations. According to the study conducted by Spong et al. (1995), a bank runs
more efficiently when the DMO either has appropriate incentives to abide by stockholder’s
interests or have a big financial stake of their own in the company. Vested interests in the
ownership and management will greatly improve the overall efficiency of the bank.
Competition and Stability
Competition plays a big role in the way that banks maintain efficiency. Competition
forces innovation and creative thinking. In the case of banks one way to be more competitive
with one another would be to increase efficiency in the banking system that is set in place. “The
consensus is that competition tends to trigger reallocations of profits toward more efficient firms
(Olley and Pakes, 1996)” (Schaeck, Cihak, 2016). This quote from a thesis paper on the
efficiency of banks discusses how a more efficient bank drives competition and vice versa. This
reallocation of profits is a way for the wealth to circulate through the banks evenly. If a bank can
not compete then they will be forced to close their doors for business or put themselves in a place
that will make them more competitive. This would be best achieved by being more efficient. The
more efficient banks will, naturally, excel and continue to make larger profits and take away
from the smaller less efficient banks. This will create an industry that, as a whole, is very
efficient (Schaeck, Cihak, 2016).
The way that competition drives profitability is much more complex than just having a
bank be more efficient. “Stiroh and Strahan (2003) find that competition reallocates profits from
weak to “well run” banks, while Berger and Hannan (1998) indicate that banks operating in
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uncompetitive markets are less efficient” (Schaeck, Cihak, 2016). Competition is not only
something that might cause banks to be more efficient but it is something that directly is linked
to banks being more efficient. The quote above confirms that a bank that is “well run”, or more
efficient, has the profits reallocated to them. With this common trend occurring, the banks that
are not efficient are forced to go out of business.
A bank's efficiency is also affected by the bank's stability. In order for a bank to be
efficient and competitive over the long term; a bank must make sure to have stable management
and control over the bank. If a bank is unstable then the bank can not maintain competitiveness.
While an unstable bank may be efficient for a small amount of time or be very competitive for a
small amount of time the bank can not maintain these levels of efficiency and; therefore, will be
unable to compete in the long term and eventually go out of business.
Technology and Bank Consolidation
The use of new technology is critical to a banks’ efficiency. Technological advancements
in the banking sector allow banks to remain consistent with future development. With most
banks heading towards complete digitalization, banks need to make changes and follow the
trends to keep their bank operationally attractive to customers. To stay consistent, cooperative
banks are adapting technology faster, providing business opportunities for leading information
technology service providers, according to Banking CIO Outlook. However, this era of
smartphones comes with challenges.
“High speed connectivity, artificial intelligence, and machine learning, innovation is
undoubtedly the key to survival, but the shift to ‘digital’ is expensive and comes with its
own set of challenges. The journey of digitalization has already started, and the initial
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phase of implementing core banking solutions has moved on to enhancing payment
offerings for customers” (Banking CIO Outlook, 2020).
Technological transformations does include the threat of cyber-attacks and fraudulent activity. It
is extremely important that as banks make these improvements, they also hire talented IT
security teams such as cybersecurity, to monitor new systems. Banks not using traditional IT
infrastructure typically see more operational expenses, rather than capital expenses.
Bank consolidation is the process by which one banking company takes over or merges with
another. Banks are motivated to merge with other banks due to the potential increase in services
to provide. The more services that are provided between two merging institutions will decrease
the overall operating costs. This increases efficiency in a bank because
“Mergers allow banks to achieve economies of scale, enhance revenues and cut costs
through operational efficiencies, and diversify by expanding business lines or geographic
reach. Bank mergers result in more efficient banks and a sounder banking system and
thus benefit the economy, as long as banking markets remain competitive and
communities’ access to banking services and credit is not diminished” (Kowalik, Davig,
Morris, and Regehr, 2015).”
In addition, bank consolidation can also reduce a bank's overall risk in the industry.
Consolidation reduces a bank's risk by allowing the diversification of asset portfolio, fee
generating activities, and funding sources. By reducing risk, banks are actually increasing their
diversification because they have the potential to operate in new or different markets. In Figure
1, below, shows that the overall number of banks in the United States is declining and the
number of single office banks has never been lower. However, the total deposit amount for the
banking industry has never been higher. This shows that bigger banks are monopolizing small
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banks and the many mergers are creating huge financial institutions that continue to follow this
pattern.
Leadership Style and Employee Job Satisfaction
The use of effective leadership is another aspect that affects a bank's efficiency.
Leadership plays a major role in business as it allows us to set objectives and reach goals that
ultimately lead to an institution’s overall success and growth. On a smaller scale, leadership
heavily impacts employee satisfaction, productivity, and daily performance. Members of
management can do this through their involvement in the decision-making processes, use of
knowledge on day-to-day business operations, as well as access to personnel information.
A study conducted in Kenyan banks showcases the strong relationship between
management styles and employee satisfaction. The journal report dives deeper into many
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different management styles ranging from performance – oriented to more participative styles
and what kinds of business environments each style is most compatible with. It shows how
leaders need to make critical decisions on what style to use after analyzing the institutions goals
and tailoring their actions accordingly. The poll results from multiple individuals working under
different management styles corroborates this relationship and concludes that “organizations
need to ensure high levels of employee satisfaction to inculcate an atmosphere of enhanced
performance levels” (Mwaisaka 42).
Outsiders, such as stakeholders and potential investors weigh their investment decisions
by observing an institution's management efficiency; they consider chief executives as primary
determinants of corporate performance (Wright 190). This is why it is very important for
financial institutions to ensure that their management has qualities that can positively contribute
to the company’s outlook and presentation in the market against its competitors. This again ties
into the relationship between leadership and employee job satisfaction as strong leaders can
influence employee performances to successfully reach set objectives and goals. Without
properly set objectives, employees will not be directed towards the best strategies and this
process collective effects the institutions overall trajectory in the market. Any outsider would
view this mismanagement as risky behavior and will be more inclined towards investing
resources in competitors with better management and higher levels of employee job satisfaction.
Data Analytics and Customer Relations
Data Analytics
While many of the aforementioned factors contribute to the efficiency of a bank, another
major factor is the data and analytics that a bank captures. In Michael Deeley’s article, Improve
Your Bank’s Efficiency Ratio By Focusing On These 4 Areas, he explains that Banks tend to
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capture a plethora of data from their customers, which can further be used in order to calculate an
efficiency ratio. According to Deely, some of the data collected by banks is:
● Core customer information
● Customer service data
● Product information
● Balance information
● Customer suitability
● Risk and compliance data
● Transaction information (Deely).
The issue with the collection of customer data by banks is the fact that most banks do not use the
data that they have gathered, as they lack data plans to ensure that the information is “actually
linked, stored and used” (Deely). Furthermore, Deely goes on to explain that the collected data
should be used in order to report the events occurring within a bank; the data should be used in
order to “drive new efficiencies” (Deely). The writer explains that if data is collected and used
in an efficient manner to discover new innovations, it is, indeed, one factor that can drive up a
bank’s efficiency ratio and improve operations.
Customer Relations
Another factor that affects the efficiency of a bank is its frontline employees. Positive
customer relations is an important aspect of every business that greatly affects its efficiency and
customer retention. In an article written by Timothy J. Reimink, Six strategies for improving
banks’ operating efficiency, staff productivity plays a significant role in the efficiency of a bank.
As previously mentioned, the tools and technology that employees are given will have a great
impact on their productivity. Reimink explains that it is not technology alone that dictates the
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efficiency of bank employees, rather, it is systems that motivate employees to utilize the
technologies that they are provided. The writer states that “some of the most significant
opportunities involve using established performance management techniques, such as clearly
defined expectations and scorecards, improved motivation and rewards systems, and better
training and supervision” (Reimink, 2019).
The writer further explains that incentives and bonuses have a direct positive correlation
with employee performances. It is made evident that one major key component to making a
bank more efficient starts with its staff members. Another article, written by Deena Zaidi, Data
Analytics in Banking, explains how technology, data analytics, and customer relations go hand in
hand. Zaidi explains that banking has become greatly affected by technological innovations, as
banks are now able to reach out to new and existing customers digitally. Zaidi explains that:
A bank’s customer base can be voluminous and gets more complicated with a number of
different financial products that the bank sells. These include mortgages, car loans, home
loans and other financial products. Traditionally, when a bank tries to sell its products to
its customers, it completely ignores the fact that the product may be irrelevant to the
customer (Zaidi, 2017).
It is evident that the human touch is still necessary and that technology should be used as a
complementary tool, not a replacement to human employees. For example, customer leads
should be filtered in terms of the service that could be provided for them. It is necessary for
employees to do their research in order to contact the right person for the right service. All of
these factors could have a major impact on the efficiency of a bank.
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Conclusion
A bank that runs more efficiently than other banks will have an active board of directors and a
daily managing officer who is relatively aligned or incentivized to follow shareholder’s interest.
In terms of competitiveness, a more efficient bank will run at a competitive advantage therefore
cycling more profits in the industry to them. The bank will also remain consistent with future
technological advancements and adapt rapidly to new innovations. Finally, it will have a strong
leadership style that utilizes the collection and analysis of data to drive innovation and create a
strong customer relations correspondence. Each of these factors plays a role in efficiency and
minimizing the waste of resources and time while accomplishing the desired outcomes. In
conclusion, more efficient banks will follow in these patterns.
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