Magazine Exclusive: The Efficiency Toolkit

Bank efficiency ratios worsened in 2023 due to rising costs and a challenging revenue environment. This complimentary article from the second quarter issue of Bank Director magazine looks at how some of the industry’s most efficient banks focus on enhancing productivity to drive their ratios lower.

Emily McCormick
Vice President of Editorial & Research

The following feature appears in the second quarter 2024 edition of Bank Director magazine. It and other stories are available to magazine subscribers and members of Bank Director’s Bank Services Program. Learn more about subscribing here.

At Bank OZK, employees strive to “get better every day, in every way,” says George Gleason.

“Every product, every process, every customer interaction, everything that we do, we’re constantly trying to improve that,” says the $34 billion bank’s chairman and CEO. A byproduct of that focus, he adds, is efficiency. 

In a year where most banks became less efficient, Bank OZK managed to buck that trend by growing revenue faster than it grew noninterest expense — which is in essence what the efficiency ratio measures. The median efficiency ratio for all public banks in the U.S. was 61.7% at the end of 2022, compared to 66.3% as of the fourth quarter 2023, according to S&P Global Market Intelligence. For Bank OZK, that metric improved to 33.2% in the fourth quarter, from 35.5% in 2022. 

“Many banks use the efficiency ratio as their de facto proxy for efficiency,” says Jeff Marsico, president of The Kafafian Group, a Bethlehem, Pennsylvania-based consulting firm. It’s calculated by dividing operating expenses — such as personnel and facilities — by revenue. Put simply, how effectively does the bank spend its money as it grows the business? The lower the ratio, the better.

Little Rock, Arkansas-based Bank OZK’s noninterest expenses rose $78 million year-over-year at the end of 2023 — a 15% increase, much of that due to higher salary and benefit costs as the bank brought on roughly 200 additional employees, Gleason says. Pre-provision, pre-tax net revenue increased 28%, topping $1 billion.

When the economy is strong, it’s easier to grow revenue and not let expenses get out of control. But loan growth was challenged last year. Meanwhile, inflationary and regulatory pressures added to the cost burden on banks. Cornerstone Advisors’ “What’s Going On In Banking” report, published in February, found efficiency and costs among the top concerns for 53% of bank executives — up from 28% the prior year.

Efficiency tends to be equated with cutting costs, but banks that excel at efficiency know there’s more to it than that. Conversations with Gleason and the CEOs of other efficient institutions, based on an analysis of U.S. public banks using S&P data, quickly focus on cultures that emphasize productivity. A bank’s business model also plays a significant role, along with managing the branch footprint. Investments in technology, while costly, can also yield important efficiencies over the long term. Significantly, these bank leaders understand that efficiency is a long game, with management teams constantly paying attention to how they can improve their business. 

Scale and size often contribute to a better efficiency ratio; so does a bank’s business model. Retail-focused operations that try to be all-things-to-all-people will have a harder road. “If you are a type of bank that has lots of different revenue lines — you have wealth management, you have mortgage banking, you have all of these other kinds of unique revenue streams — it is harder to always hit on those efficiency metrics,” says Kara Baldwin, a partner and financial services audit leader at Crowe LLP. Banks with a lot of branches will naturally have to spend more on people and staffing. And some bank holding companies still operate multiple charters, with different accounting systems and duplication in some positions. That can drive costs up, too.

Many of the industry’s more efficient performers operate branch-light footprints. Bank OZK has more than 200 retail branches across the southeastern U.S., primarily in Arkansas, Georgia and Florida. But it also operates national business lines such as its commercial real estate construction and development lending arm, which contributed the bulk of OZK’s loan growth for 2023. 

Branch-light operations, or models that lean heavily on specific niches, don’t come without risk. The three banks that failed last spring had highly targeted clientele and few offices. 

Scrutiny has shifted to banks with large commercial real estate portfolios. In October 2023, Kroll Bond Rating Agency revised its outlook for Bank OZK from stable to negative based on concerns that the bank’s capital ratios were low compared to its “outsized” loan growth and recent share repurchases. KBRA explained further, in a November report, that “the bank is exposed to large, single name commitments, including 22 loans with a total commitment of over $250 million, representing approximately 27%” of its real estate specialties portfolio. Bank OZK’s common equity tier 1 capital ratio remained steady at 10.8% at the end of 2023, per the bank’s annual report. Regulators would generally consider that well capitalized.

Five Star Bancorp in Rancho Cordova, California, also has a strong focus on commercial clients. 

“We’re not all things to all people. We don’t have a retail component, which can be costly,” says James Beckwith, CEO of $3.6 billion Five Star. “That’s helped us over the years to be efficient.” The bank had an efficiency ratio of 44.0% in the fourth quarter 2023, and a median 38.7% efficiency ratio from 2018 through 2022. That’s considerably lower than the 68.5% median efficiency ratio reported by similarly-sized public banks in the fourth quarter. That group reported a low-60s median during 2018-22.

Neil Hartman, a senior partner focused on financial services at West Monroe, thinks commercially-focused banks can generate even more efficiencies as digital capabilities catch up with how banks have evolved to serve retail clients, which have seen broader adoption of digital deposit account opening and digital loan applications. “Executives need to start thinking about, ‘What do my commercial banking operations need to look like in the next three years?’”

Now isn’t the time to scale back on investing in technology, says Baldwin. “You can’t cut costs into profitability,” she says. “It’s a very short-term fix.” Banks that dial back those investments risk sacrificing future revenue or future efficiency in return. 

For decades, technology has helped banks gain efficiencies, particularly in serving customers — starting with the introduction of automated teller machines in the late 1960s. Now, artificial intelligence-powered chatbots offer banks a way to resolve simple customer problems without involving a bank employee. AI can also help banks better detect fraud, turning manual processes into automated ones.

New York-based Valley National Bancorp uses AI to assist compliance investigators tasked with transaction analysis, which Chief Operations Officer Russell Barrett explained to Bank Director for a February research report, “Artificial Intelligence: A Real-World Approach.” It takes time to rule out false alarms within compliance alerts, but AI can make recommendations that bank employees can incorporate in their decisions. Since launching in 2023, investigation time decreased dramatically, from two weeks to two minutes. 

Marsico expects more banks to adopt automation and AI to simplify processes and free up staff. “If there is something that somebody in your bank is doing with a checklist, it probably could be done by robotic process automation, and we have not fully harnessed that.” 

Gleason and Beckwith describe technology as an area of constant focus for their respective organizations. Bank OZK invests in staff — roughly 40 to 50 technologists in its OZK Labs group — to write code, build apps and create new solutions as well as supplement the third-party technologies used by the bank. “Those guys are not running systems. They are helping build, augment, manage and continuously improve systems,” says Gleason. “That’s a big benefit to our productivity.” 

Five Star uses Q2, a digital banking provider, and nCino, which operates a cloud-based platform that offers loan origination and account opening. Beckwith believes that banks that didn’t invest in similar technologies over the past decade will be seriously behind when it comes to growing revenue and reducing costs — the contributors to efficiency. “To do it today, it’s just more expensive,” he says. “When you make these investments, you project yourself forward. ‘What am I trying to achieve over this timeframe? And what do I want to look like three years from now? What type of operating environment do I want to have?’ It’s always forward thinking.”

Having a strong strategic vision for the bank contributes to achieving greater efficiency.

“Everybody needs to get a sense of where they want to be as an institution,” says Paul Davis, director of market intelligence at Strategic Resource Management, a Memphis, Tennessee-based firm that negotiates contracts for financial institutions. “Work backwards from there. Figure out the staffing you have to have in place, the technology you have to have in place, the markets, the demographics, everything.” That strategic road map will help management teams and boards consider where they’ll generate revenue — and where to make cuts.

Baldwin says banks can look hard at processes to assess where to deploy technology or make other changes. Start by looking at how many employees are involved in a process — originating a loan, for example — along with how many steps there are and whether that’s all necessary to maintain proper controls and meet compliance requirements. Other changes could include hiring a third party or using software to help mitigate compliance costs, or even simply negotiating a landscaping contract for the bank’s branch network instead of relying on each branch manager to find someone to trim the hedges. That negotiation could yield a better price, she says.

The Cornerstone Advisors survey in February found more banks focused on negotiating vendor contracts to yield savings, up from 18% last year to 31% indicating it’s a priority for 2024.

Banks could also engage employees to come up with ideas to reduce expenses, offers Davis. “That can help everybody feel like they’re pulling their weight and making it more of a cohesive, collaborative process, as opposed to management coming in” and making cuts. 

Technology can represent a significant long-term expense for banks, but so do branches. Data shared by Raymond James Financial analyst David Feaster at Bank Director’s Acquire or Be Acquired Conference in January indicated that branch costs represent the largest portion of a bank’s costs, with occupancy and personnel representing roughly 60% of total expense.

While banks operating branch-light models might find themselves naturally more efficient, there are ways for more traditional operators to trim expenses. 

Business-focused CVB Financial Corp., with $16 billion in assets in Ontario, California, takes an intentional approach to staffing its 62 locations, primarily in southern and central California. CEO David Brager says those centers would typically house a manager, lenders and an operations team, along with a treasury management salesperson and staff focused on Small Business Administration loans, home loans and equipment financing. “In a central location, we’ll have larger offices that have all of the people required to present our wide array of products to our customers and sell deeper into those relationships,” he explains. It’s a more efficient, cost-effective way to serve clients rather than having a sprawling branch network. 

In Bank OZK’s more extensive branch footprint, Gleason says the bank owns most of its locations, rather than leasing the space, which he says helps the bank control that cost. And the bank regularly examines its branch network. “Over the last four or five years, we’ve closed a handful of branches or sold a handful branches every year because our business shifted, and technology has shifted the way customers interact with branches,” he says. “Because we own that real estate, we’ve had a lot of gains on sale from liquidating that real estate.” The bank may find it needs fewer branches in one location, or that it should expand in another area. Gleason says that has resulted in a relatively stable branch count, despite the bank’s growth.

But many community banks don’t approach the decision to shut down a branch as a purely financial consideration, says Marsico. “Will the town think we’re weak if we close a branch, or that [we’re] abandoning them? And I don’t know how to solve that on a spreadsheet.” 

Banks should pay greater attention to this problem, he says, as the country’s demographics continue to shift. While customers in their 50s and 60s may have higher average deposits, relationships with younger customers — who tend to avoid visiting a branch — will become increasingly valuable to financial institutions.

Bank OZK is saving money in branches in another incremental way. As part of its clean energy commitment, the bank broke ground in June 2021 on a solar facility that now powers its corporate headquarters and roughly 40 Arkansas branches. That move wasn’t made with efficiency in mind, says Gleason, but it could have a small, long-term impact. “It will tend to cap our energy cost” over the next several decades, he says. “So, it will take the inflation element out of our energy costs for that part of our organization.” That should yield a “marginal, long-term impact on efficiency.”

But pruning branches and generating its own energy run second to culture and the bank’s people in driving efficiencies, says Gleason. “[Our] culture of excellence inherently results in a culture of efficiency,” he says. “Higher performing employees are more efficient than poor performing employees.”

That means spending more to hire the best. He offers a hypothetical example: You can hire someone for $80,000 a year, or hire an individual who promises to be more productive at $100,000. He’d rather pay a higher salary. “In my experience, in that hypothetical situation, the $100,000 employee is going to produce twice as much as the average, $80,000 employee,” Gleason says. “Spending more money for people, in a counterintuitive way, leads to greater efficiency — because the better person you hire, even though you paid up for them, is likely to make a much more than proportionate increase in the productivity of your company.”

As Gleason illustrates, talent is an expense that’s also a long-term investment. And it’s hard for banks to cut talent; Cornerstone Advisors found that only 17% of executives said reducing headcount was a priority for their bank.

That runs counter to announcements from some larger banks throughout 2023. In September, Truist Financial Corp. CEO Bill Rogers announced its initiative to eliminate costs by around $750 million over a 12- to 18-month period, which would flatten expense growth. In the Charlotte, North Carolina-based bank’s fourth quarter 2023 earnings call, in January, the $535 billion company stated that through business line restructuring and other moves, it reduced headcount by 4% — more than 2,000 employees — over the second half of 2023, with more reductions expected in early 2024. And CNBC reported in October that while JPMorgan Chase & Co. increased its employee count in the first nine months of 2023, the next five largest banks reduced headcount by a combined 20,000 positions. 

But most banks don’t have room to cut staff, says Hartman. On the heels of the 2007-08 financial crisis, the industry had “massive layoffs” and “never really recovered.” Efficiency ratios improved afterward; banks grew revenue without drastically adding staff. “But now, they don’t have that lever — or as big of a lever to pull in the environment that we’re in now,” he says. “That poses some interesting challenges for bank executives.”

And a growing compliance burden continues to add to staffing needs, says Brager at CVB. “When I started at the bank 21 years ago, we had two people in our risk management group. Today, we have over 50.” About half, he says, focus on the institution’s Bank Secrecy Act compliance program. That’s despite automating some of those tasks. 

Beckwith says Five Star is paying more for talent to fuel its growth — the bank hired former employees from Signature Bank and First Republic Bank after those institutions failed last year. Five Star will probably open another office as well, adding to its seven-branch footprint. 

“They’re very expensive people,” he says. “But jumping into the Bay Area market, costs are higher.” Beckwith says he’s focused on playing the long game. “It is costing us money right now, but we think in the long run it will pay off.”

Hiring is expensive, but it’s sometimes required to grow. Retaining staff, as a general rule, is more cost effective than hiring and developing new employees.

“We want to be the employer of choice for the top 25% of bankers out there,” says CVB’s Brager. Getting that talent requires more than a good salary. CVB expanded its equity benefit, so more of the bank’s associates can have ownership in the bank. He’s also invested in developing them. “You need to make sure they have the ability to be rewarded financially, career-wise, whatever their drivers are.”

CVB also conducts an annual employee engagement survey — an additional expense but one that adds value, according to Brager. “Engaged associates are much more productive,” he says. “We want to keep driving our engagement level higher, which we believe will drive more efficiencies and more productivity.” Productivity drives revenue, which improves the efficiency ratio.  

But watch out for small, expense-curbing efforts that negatively affect employees, like cutting pay or reducing 401(k) matches. “Those tend to feel less positive and more like your bank is in trouble,” says Baldwin. And that temporary bump could drive valued staff away, creating a long-term problem.

As banks work to become more efficient, it’s important to ask: How low is too low when it comes to a bank’s efficiency ratio? 

“The lowest efficiency ratio organizations aren’t necessarily the best run,” says Hartman. And regulators could become concerned that the bank isn’t investing enough to run a safe and sound organization. 

Baldwin says regulators will worry less about a bank that has exhibited a gradual path to efficiency — through changes to its operating model or technology investments — compared to one that quickly hits a super-low efficiency ratio via drastic cuts. “That is more of a red flag than someone who’s consistently done well on the efficiency side,” she says.

Banks that balance efficiency with profitability take a constant approach to perfecting their enterprises, making adjustments that align with their long-term strategies.

It’s a continual process at Bank OZK, where the management team constantly evaluates “all aspects of the organization,” says Gleason. “I personally have a discussion about every single employee in our company every year.” That means looking at its locations and examining staffing, making adjustments along the way. High performers can be moved from one location to another, if necessary; those who don’t meet expectations can be let go. 

 “If we said we were going to cut 5% of our staff, that would be a totally stupid, absurd day,” says Gleason. “We’re constantly combing and refining and studying the whole company on a continuous basis. That’s why you don’t see us with the same sort of layoff announcements that a lot of banks have.”


Emily McCormick

Vice President of Editorial & Research

Emily McCormick is Vice President of Editorial & Research for Bank Director. Emily oversees research projects, from in-depth reports to Bank Director’s annual surveys on M&A, risk, compensation, governance and technology. She also manages content for the Bank Services Program. In addition to regularly speaking and moderating discussions at Bank Director’s in-person and virtual events, Emily regularly writes and edits for Bank Director magazine and She started her career in the circulation department at the Knoxville News-Sentinel, and graduated summa cum laude from The University of Tennessee with a bachelor’s degree in Spanish and International Business.