Cost rationalization and efforts to improve efficiency ratios are important themes in 2012 and likely for the next few years. Much of this effort is likely to focus on the Branch, given that branches and associated branch expenses constitute 60% – 70% (and in some instances much more) of the total cost base for Community Banks and Credit Unions.
For this reason, the article published in the BAI Bank Strategies authored by James McCormick, Founder and President of First Manhattan Consulting Group, entitled Branch Consolidations: Handle With Care troubles us.
We agree with Mr. McCormick that it is essential for Bankers to understand the challenges and benefits of branch network rationalization, especially in the current environment of weak loan demand, intense competitive threats, transition of sales & service activities into online & mobile channels, and ever growing regulatory burden. There is no doubt that any reorganization, streamlining, and rationalization efforts requires careful planning and execution. However, some of the “concerns” identified in this article may not be relevant in today’s environment, and at a minimum, require further explanation (note: FMCG did not respond to a request the full study):
Focus on high-revenue customers vs deposit attrition
We concur 100% that Banks, and especially Community Banks, must refocus their attention on the “high-revenue customers” however, most high-revenue customers tend to avoid the Branch as they tend to be much to busy. For this and other reasons, branch consolidation is unlikely to negatively impact these relationships.
The study attempts to link high-revenue customers with deposit run-off stating that “… revenue-crushing 55% of deposits consolidated from a closed brach are lost” in 20% of consolidations. FMCG goes on to say that “As a consequence, we estimate that 60% of branch consolidations resulted in a negative net present value (NPV) because of higher-than-acceptable attrition”. It goes without saying that deposits do not generate revenue. Deposit runoff does not suggest any (meaningful) impact to revenues. Indeed, in an era of 70% Loan / Deposit ratios, many Banks will find deposit run-off to be beneficial to their bottom line, and most Banks will be able to sustain significant deposit run-off without impacting revenues at all.
We however agree that Banks, those consolidating branches and not, ought to spend a disproportionate effort on their top 20% customers who typically generate more than 240% of total profits. Likewise, smart Bankers will deploy creative strategies to convert some or all of the remaining 80% of customer relationships that presently generate net profit losses exceeding 140% of total profits into profitable or at least, break-even relationships.
Data used to support findings is stale
Mr. McCormick writes that his firm looked “… at more than 1,000 branch pairs that were consolidated over the period 2004 to 2009…”. However, much has changed since 2009, and certainly since 2004. The data does not account for considerable shifts in virtually every aspect critical to competitiveness, and thus, may be too stale to be of value. Most will recognize significant shifts in consumer preferences and demands, changes in competitive environment, significant shifts in the overall economy impacting demand, technology changes, and last but not least, evolution of regulatory oversight since 2009. As such, the 2004 experience may no longer be relevant to the environment Banks face today and, more importantly, the environment they will face tomorrow.
Correlation vs Causation
The article appears to imply correlation between closed branches, deposit run-off and revenue shortfalls, but the evidence presented has not clearly demonstrated a causal relationship. That is, we have no way of knowing if the deposit-runoff and revenue shortfalls resulted from consolidation, or perhaps other factors, such as Banks’ exist of specific territories, non-Bank specific events such as the 2008 Banking crisis, exit from one or more products or services, or a variety of other factors. As such, readers should be cautious in relying on these findings.
Branch consolidation is certainly not easy nor simple. The adage of “If it were easy, everybody would be doing it.” comes to mind. No doubt that many branch consolidations have fallen short of anticipated results, but this can be said of virtually any activity. The process of creating value should be challenging… it requires commitment, expertise and “sweat”. We urge all Bankers to review their business strategy and, where necessary, to (re)align products, channels, pricing, messaging and other capabilities appropriately as this is much more critical now than it was in the past.
Serge Milman is the Principal Partner of San Francisco, CA based SFO Consultants and Principal of Optirate – a blog dedicated to growth and profitability strategies for Banks and Credit Unions. He can be reached at info@SFOconsultants.com.