Today’s business environment requires increasingly rigorous efficiency to remain profitable. Operational efficiency in banking is commonly highlighted by cost/income ratios – that is, the ratio of total operating costs (excluding bad and doubtful debt charges) to total income (the sum of net interest and non-interest income).
The Australian big four banks’ cost/income ratios have been at the bottom end of the range of their peers in recent years, contributing to their higher profitability. Banks have driven ratios from the 40% range in 2010–12 to the 30% range as of 2016.
Banks’ cost/income ratios can be broken down into various categories of operating costs:
- other costs (which include expenses such as marketing, litigation etc.)
Personnel and IT costs are the largest components of banks’ total costs and, as such, are important drivers of cost/income ratios. In keeping with this, the banks that reported the lowest ratios in the sample benefitted from the lowest personnel and IT costs.
What is driving this outperformance?
The big four Australian banks have renewed their focus on costs in the past few years in order to increase profits. The big four (ANZ, National Australia Bank, Westpac, and Commonwealth Bank of Australia [CBA]) report that their investments in digital technology and automation – coupled with initiatives to simplify processes and remove complexity from products – are improving their efficiency and productivity levels.
Chief among these efforts have been investment in core banking upgrades, with CBA leading the way. In its 2016 annual report, CBA notes that its cost-reduction initiatives (driven by technological development and outsourcing) have proven successful. As shown above, CBA achieved a notable cost/income ratio of 33% for its retail business in 2016, leveraging its new banking platform to drive down costs. Even the other majors will have to work hard to drive similar efficiencies in their retail bank, let alone the regionals and mutual banks. Australian banks must move beyond tactical cost reduction if they want to catch the market leader.
By Resham Karira, Retail Banking Analyst