Making Tradeoffs in Branch Efficiency

Banking Strategies Magazine.
September 17, 2009 | COMMENTS

The physical branch network still anchors most customer relationships in retail banking, both for households and small businesses. But branch networks became conspicuously overgrown during recent expansion years. They now represent over half of the total expense base in retail banking. Banks are grappling with the question of how to reduce branch expenses without harming their franchise.

The answer won't be found in traditional strategies for branch network efficiency enhancement, according to Novantas consultants writing in the Bank Administration Institute's Banking Strategies. Conventional approaches pose pitfalls in three main areas: branch locations, formats, and activities. In all three, there's a risk of economizing in ways that further embed current flaws, limiting the potential for long-term improvement.

Along with fixing flaws, institutions first must develop a vision for the future role of the branch network, says Novantas. Only then can they harness short-term efficiency adjustments to help move networks to a more productive configuration.

Two of the efficiency pitfalls related to branch locations include basing closures strictly on individual branch profitability, and retaining broad geographic coverage no matter how thin it might be.

It's tempting to simply eliminate the least profitable branches, as shuttering the weakest locations can provide a short-term lift. But when such cuts cripple local network density and dilute service, long-term deposit growth can be compromised. Below certain density levels, Novantas research shows that branch networks begin to lose share in "micro-markets," or local geographic areas where target customers live, work, and shop.

Also, there's a powerful tendency in branch banking to emphasize territorial coverage, no matter how thin. But there are drawbacks in maintaining "orphan" branches far removed from any other outlets within the network. Orphan outlets divert resources and capital away from micro-markets where the network is better established and has more growth potential.

To dodge location-related efficiency pitfalls, Novantas recommends that financial institutions examine the larger question of local network strength. At certain levels of local density, networks can capture deposit share that exceeds their share of physical outlets. Novantas calls this "network equity," and it reflects how, within a certain range, clusters of branches tend to reinforce each other in critical aspects, such as brand presence and overall consumer convenience. Thus, the local branch network is a strategic asset that needs to be managed around the twin principles of location and density.

In markets where there's a thin network presence, for example, network performance can easily be made worse by cutting the weakest outlets. In some cases, a better route might be to improve management at the weak units and actually increase the local branch count. In other cases, it might be better to exit a thinly-covered market.

In overly dense local networks, by contrast, it may help to weed out a few lagging branches even though they might be out-performing some units in other markets. In such circumstances, closures could actually help improve micro-market performance and better position the overall network for longer term growth.

One of the traps related to branch format is maintaining a full range of services for all customers at all branches. Universal full service typically extends costly capabilities into numerous areas where there is insufficient demand. Consider the costs of staff expertise and other resources required to offer a broad product set and extensive service capabilities at all outlets.

Efficiency pitfalls related to branch activities include piecemeal automation, reallocating workloads instead of streamlining, and mandating across-the-board expense reductions without careful thought of how to reduce the workload.

Regarding piecemeal automation, Novantas observes that retail banks easily can overload themselves with splinter technology projects that, while individually compelling, rarely come into full use or sufficiently offset other activities. Innovative offerings such as branch image capture and the use of radio frequency identification for payment devices might be based on unrealistic assumptions about widespread consumer adoption.

Given the pressures faced by many financial institutions, industry experts anticipate sharp branch cost cuts. The winners in this game will be financial institutions that seize on efficiency initiatives as an opportunity to reposition for future profitable growth.

Reprinted with permission from BAI's Banking Strategies magazine.