James White, GM, Banking, Total Expert
While bank stocks may have rallied from the earlier spring selloffs, many investors are hesitant to go all-in. Growing cost pressures and economic uncertainty still exist, and there is a need to refocus their financial strategy to restore healthy profit margins, return on equity (ROE), and return on assets (ROA). For modern financial institutions, this means thinking about return on investment (ROI) in an entirely new way: one that doesn’t rely solely on cost-cutting to achieve.
Traditional ROI Models
Let’s break this down. High-performing organizations achieve their financial goals and a solid ROA/ROE through higher average balances and by generating more revenue for every dollar they spend. This model requires a heavy focus on metrics and data.
With that increased focus on metrics, ROI has become a standard performance measure. It considers the cost, project risk, and timeframe required to generate and maintain a healthy return. It is an essential metric for any business, especially for banks and credit unions, despite losing much of its power with CFOs.
A high direct attribution ROI with a focus on the revenue side of the equation is the best way to ensure that a business will be successful and profitable in the long run. It also helps companies avoid making costly mistakes that could harm operations and profitability through opportunity costs and unintended consequences.
In the past, the average ROI for the S&P 500 was about 10%, although it can vary depending on the industry. Yet financial institutions don't have a set standard or baseline. They are generally encouraged to aim for an ROI more significant than their cost of capital and the return they can earn from alternative investments with similar risk.
Additionally, most financial institutions do not have a way to accurately measure ROI and time to value. And now, the pressure for accountability is making leaders increasingly nervous about committing to ROI estimates.
Because of this, many financial institutions revert to their natural tendency, which is using across-the-board cost-cutting efforts to improve operations, hit margin targets, and reset their business. This may be a good short-term strategy, but it has potentially devastating ramifications for long-term growth, customer experience, and investor confidence.
Looking at ROI through a more strategic lens
Instead of blanket cost reductions, smart financial institutions are taking a step back and looking at what creates ROI over the long term and doubling down on those investments. While this might not show immediate or short-term returns, the health of the organization will benefit and create a better, more sustainable growth path.
Simplify Products and Services
Radically simplifying the products, services, and underlying processes that a bank or credit union offers can help reduce expenses by decreasing complexity. This is particularly true if a financial institution sells and supports multiple, closely related products through different channels, multiplied with separate underlying processes. This is often an issue after mergers and acquisitions.
Instead of being everything to everyone, institutions can drive better ROI by servicing their niche better than anyone else. This model is proven by lots of organizations in other industries. Portfolio diversity can still exist to reduce risk, but with a heavy priority on fitting into the overall niche of the business.
Simplifying requires a clear understanding of product and service offerings to determine which ones are worth keeping and which can be eliminated or downsized. This can be done by conducting an audit, reviewing operating and asset-weighted expense ratios, and using profitability reporting to identify which products are most profitable for a specific customer or member.
Banks and credit unions should only consider integrating new products and services into their existing portfolio when it meets the financial criteria and gives customers and members a better experience. Every offering should have direct attribution to expense savings, revenue generation, loyalty, or growth. Following this approach can both reduce costs and set the stage for sustainable growth and ROI.
Streamline Vendors and Software
Regardless of the product and service offering mix, banks and credit unions need to do a better job of evaluating, marketing, delivering, and supporting these solutions. A lot of upfront cost goes into developing offerings and creating the underlying infrastructure, so they need to be properly vetted, promoted, and supported to create ROI.
It’s essential that organizations evaluate the vendors and technologies that support core offerings. There’s often overlap across vendors, and an audit can shed light on areas to consolidate or areas where a best-of-breed solution is required. Vendors often try to hide within the organization and ride the auto-renewal contract wave, so a regular review is critical.
Like with products and services, banks and credit unions must focus on the tools and technology that drive customer experience, attract more deposits, and encourage lending and other revenue-driving activity among customers and members.
Cutting valuable staff to nurture relationships and close deals is short-sighted, but giving these employees the right tools to understand customer needs and intent can increase pull-through, boosting revenue.
Financial institutions can set themselves up for success when the economic pendulum swings back in the other direction, but only if they start to think differently about what builds long-term ROI and ultimately strong ROA and ROE. By generating more revenue for every dollar spent, banks and credit unions can more easily weather the current environment of cost pressures and economic uncertainty without resorting to wide-reaching cuts.
Creating this cultural shift is a process that starts with identifying and supporting ROI-generating offerings and underlying technologies, setting goals for measuring ROI, and reporting on individual products. And it doesn’t happen overnight. Long-term sustainable growth is possible, but changing our mindset and approach to each project and strategic initiative are both necessary to make it a reality.
About the author
James White, General Manager of Banking at Total Expert, has over 25 years of experience helping modern depositories grow market share and drive profitability. James’ leadership experience spans strategic planning, product development and delivery, professional services, sales and marketing, and customer success. Having worked with the largest banks and credit unions in the world, James believes in the power of an empathetic bank or credit union to create customers for life.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.