Over the past two years, the banking industry has enjoyed exceptionally strong performance. Earning assets have grown rapidly, net interest margins have been wide, and the industry has had ample room to add leverage loans and long-term debt. As a result, bank management's emphasis has been on increasing the volume of earning assets and return on equity.

Recently however, it has become clear that these growth avenues are narrowing. Net interest margins are declining, competition is intensifying, and investors are voicing concern over continued capacity for growth. The developments, combined with spiraling labor and facilities costs, are forcing the industry's top executives to look for new and innovative ways of controlling operating expenses. A prime object of their attention has been banking's largest individual source of non interest expense -- personnel and its related social cost.

Before a bank embarks on a personnel cost-reduction program, the Chief Executive usually wants to decide two fundamental issues. One is "How much and where can I reasonably ask my staff to cut?" The second is "Which of the various techniques should we use to effect the necessary cuts?"

The answer to the first question will be based on numerous analyses, but will include: (1) comparative review of published financial data to highlight trends of profits, returns and personnel expenses, and (2) comparisons of staffing levels in various functions -- a technique for which this bulletin provides some general guidelines. The question of how to most effectively cut cost is best answered once the area of greatest opportunity is located.

BENCHMARKING AS AN APPROACH

The objective of benchmarking is to give participants a focus for cost-reduction efforts and not to pass judgment on staffing levels or on the efficiency of the employees. ~ In specific, the objectives are to:

1. Give top management a basis for assessing the magnitude of cost-reduction opportunity

2. Help set priorities in initiating specific profit-improvement projects

3. Provide supporting evidence for recommendations to: (a) reduce a particular staffing level or increase workload; (b) undertake new activities: or (c) consolidate existing activities.

This third objective becomes particularly important when the Board or several senior officers are reluctant to actually adopt proposed staff reductions.

The first step in the benchmarking process is to define the sample from which the comparative data is drawn. To have validity, the sample should consist of at least seven banks of similar characteristics, especially in terms of wholesale/retail orientation, asset and liability mix, and number of branches. Obviously, the greater the number of participants and the more alike they are, the greater the creditability of the results.

The second step is to gain a perspective on staffing costs of the participants by analyzing personnel expenses. Conventional analyses such as personnel expense as a percentage of adjusted revenue and operating expenses (i.e., excluding interest paid), comparative growth in personnel expenses relative to assets, revenue and total non interest expense, comparative growth in number of personnel and cost per employee are useful for this purpose.

With a general grasp of the situation facing the participating banks, it is possible to define the parameters of benchmarking process:

Distribution of results. Compiling the benchmarking data can involve a considerable effort (5-10 Mondays) on the part of the personnel or controller's department and, therefore, banks will be reluctant to participate if they can see no clear benefit to themselves. As a result, the survey will have to be made available to all the participants, not just the initiating bank.

Confidentiality. Banks will absolutely refuse to participate if they perceive any competitive threat or embarrassment from the distribution of their staffing data. As a result, the participants will almost always want to keep the results confidential.

Conduct of survey. An individual bank can obviously get together with others who desire the same information and conduct the survey. Alternatively, they can (as a group) employ an independent consultant or survey firm to keep data confidential, enforce common definitions, and interpret the results to the needs of each of the participants.

Bases of comparison. In the course of previous surveys, the most useful basis of comparison has been percent of total personnel, measured in terms of full-time equivalents. This, however, ignores all aspects of productivity. As a general rule, the more precise the basis for productivity comparisons, the less reliable the data because of the definitional problems involved (i.e.' the number of studies issued per economic/planning employee is not as reliable as the assets per employee).

Data collection. To be assured of comparable data for inter bank staffing comparisons, data must be collected by function, not organizational unit. Since the participants are organized differently and since the same function is often performed in many departments (e.g., each major department may handle its own personnel function), this approach is the only valid basis for comparison.

Definition of terms. Agreement between the participants on a definition of terms is essential. In defining the narrower the categories become, the greater the risk of inaccuracy in the data. To lessen this risk, three major groupings should be used that parallel the types of activities performed in any bank.

1. Customer-related functions. These are the Unctions that bring employees into regular contact with third parties. Personnel in this group include loan officers, branch employees, and account representatives -- in other words, all who work on the selling floor. Staffing here is more likely to be under control because performance can generally be measured. For example, tellers can be evaluated by the number of transactions handled; loan officers, by loan and deposit volumes, number of accounts managed, or new accounts developed; and branch managers by the activity and contribution of their branches. Improvements in each of these measures can be followed over time.

2. Process-related functions. These functions concern the bank's "paper factory" (e.g., check clearing, loan processing, EDP, and other paper-processing activities). Typically, employees in this group do not have customer contact but? without their efforts? all customer record-keeping, check processing and loan activities would cease. The performance of these employees is also relatively easy to measure (e.g., number of items encoded per employee, number of checks processed per minute) and, thus, subject to continuing scrutiny and control.

3. Supervisory and support functions. These are the functions performed by employees responsible for determining and applying policies and procedures that make the operation and expansion of the bank possible. Few performance measures exist for these employees. Given the lack of measures and the high cost of these personnel, the bank is most vulnerable to ineffective planning and control and to rapid cost escalation among this croup.

Another definition which may require agreement is the term "officer." Since one of the ways of reducing personnel costs is to lighten the staffing mix, a comparison of the officer content of similar functions can be very useful information. For the purpose of past surveys? officers have been defined as "those employees who have the power to commit the bank to an unrelated third party for however small an amount of the equivalent staff rank."

FINDINGS OF BENCHMARKING STUDIES

The interviews conducted during the benchmarking study tend to reveal three deep-seated fears of top-banking executives: (1) the fact that increases in personnel costs arc outpacing the bank's growth; (2) a growing realization that budgeting procedures typically require the justification of only the additions, not of the total staff; and (3) the increasing number of central staff areas whose productivity cannot be measured and that are determined solely by management discretion. Some more detailed findings are discussed below.

To draw some overall conclusions on the total staffing of the participants, rout comparisons of productivity are valuable. Statistics such as assets, deposits, loans, revenues and expenses per employee are useful in assessing which of the participants make the most effective use of their employees.

Another overall comparison can be made by comparing the overall officer content of the participants. As a general rule, wholesale banks have a richer mix of officers with an average of 20 percent of total staff(compiled from previous surveys) than the retail banks (which average closer to 18 percent). Two reasons explain this difference: (1) wholesale banks have a more sophisticated customer base than retail banks, and thus have a greater need for senior staff; and (2) wholesale banks have fewer branches, which reduces their total number of personnel For the same reasons, wholesale banks tend to have a richer mix of top and senior officers.

Top management includes CEO, COO, members of the executive office and EVPs. Senior management includes senior VPs and higher level VPs responsible for broad elements of bank business. Middle management includes VPs with specific line and staff responsibilities. Supervisory personnel constitute the remainder of the officer complement.

As one might expect, retail banks have a much greater commitment to customer-related functions than wholesale-oriented banks. In aggregate, large retail banks have about 51 percent of their personnel in customer-related functions, while wholesale banks average less than half that number (Exhibit 2).

On the other hand, the wholesale-oriented banks have an appreciably higher proportion of officers among their customer-related personnel, about 28 percent compared to 21% (Exhibit 3). This is a reflection of the comparatively greater sophistication of wholesale bank customers.

The benchmarking survey indicates that wholesale-oriented banks have about 45 percent of personnel committed to process-related activities (about 45 percent) compared to retail banks which usually commit about one-third of their total employees (Exhibit 2).

In terms of officer commitment, both retail and wholesale participants generally staff process-related functions with fewer officers than any other category. Presumably, employees in this group need less supervision, since they make few decisions and transcribe or process data rather than use it for decision-making (Exhibit 3). In manufacturing parlance, the span of control can be greater in the factory than in the sales force or corporate headquarters.

Wholesale banks have a strong commitment to supervisory and support functions, averaging about 32 percent, or roughly twice that of the retail banks. Since these supervisory and support activities are often more crucial to the working of a wholesale bank, this finding is not surprising (Exhibit 2).

The benchmarking statistics indicate that staffing levels in the supervisory and support category are growing at 19 percent compared to 99 in customer - related functions. (Exhibit 4). A continuation of this feud may become a threat to continuity bank profitability.

            GROWTH WITHIN SUB-CATEGORIES OF BANK STAFFING



      Supervisory & Support                  Recent Annual Growth

        Personnel                                    19%

        Research & Statistics                        17

        Accounting Control                           17

        Computer Services                            29

        Marketing                                    18

        MIS Development                              21



        Overall Weighted Average                     19



      Customer Related

        Retail Services                              10

        Commercial Services                          12

        Credit Card                                  16

        Mortgage                                      4

        Installment Loan                              6

        Foreign                                       8

        Trust                                         5



        Overall Weighted Average                      9





      Process Related

        Check processing                              4

        Cash and collection                           7

        Trust operations                              4

        Wire transfer                                30

        Proof and transit                             7

        Loan operations                               2



        Overall Weighted Average                      8





       Source: Benchmarking Survey

      ILLUSTRATIVE PRODUCTIVITY BENCHMARKS FOR SUB-CATEGORIES

            OR SUPERVISORY AND SUPPORT BANK PERSONNEL



                                 Avg. FTE*Per Unit Of Measure



                                  Unit                    Total

  Function                     Of Measure    Officers   Employees



  Economic Research              Assets

  and Planning                ($1 billion)       2          4



  Money Market Activities        Assets

                              ($1 billion)       5         13



  Personnel                     Payroll

                             (1,000 people)      6         20



  Marketing                   Total income

                             ($100 million)      2          5



  Accounting & Budgeting         Assets

                              ($1 billion)       4         13



  Auditing, Tax & Legal          Assets

                              (51 billion)       5         11



   * FTE = Full time equivalent

The data shown in Exhibit 5 is drawn from a sample of 11 large banks. These benchmarks provide some interesting initial rules of thumb which may be useful as a starting point for more detailed study of utilization and efficiency. For example:

• The banks surveyed to date average 20 people in the personnel function -- 6 of whom are officers, for each 1,000 bank employees.

• Similarly, the number of employees in the accounting and budgeting function averaged 13 per $1 billion of assets, of whom 4 are officers.

These rules of thumb are not intended to be relevant to any individual bank, the staffing requirements of which are obviously defined by broad strategic, competitive, and organizational characteristics.

PROCEDURES TO IMPROVE PERSONNEL COST CONTROL

The benchmarking studies inevitably lead to the conclusion that banks should look at personnel cost-reduction opportunities in terms of distinct functions-customer-related, process-related, and supervisory and support. Only with a clear understanding of the different characteristics of each function can the most appropriate and effective cost-reduction technique be selected. This selective approach is important. Historically, banks have resorted to arbitrary techniques, applying them regardless of the nature of the functions in which the potential savings lie, only to find the reductions do not last.

The four basic methods of cost reduction historically used by the banking community are:

1. Top-management edict (e.g., "cut all budgets by 10 percent, freeze hiring, commence firing")? which is? on the surfaces applicable to any function or department. It has the disadvantage, however, of being highly discretionary, without factual or analytical base and, consequently, short-term in impact, as well as demoralizing.

2. Profit-improvement program (PIP), which requires a team of skilled employees' specially assigned for a long period. Generally, this technique is suitable for either increasing revenue (such as developing new products or markets) or reducing "big ticket" expense items. Typically, a PIP team would deal with changes in bank philosophy that have to be supported by heavy expenditures.

3. Administrative cost reduction (ACR), which requires a systematic evaluation of routine administrative functions (e.g., handling of withdrawals by branch tellers, loan approvals). This technique is generally suitable for repetitive customer and process-related functions.

4. Overhead Valve Analysis (OVA), a technique which that ranks the value of end products or services produced by all of the staff and then forces line managers to assign priorities to the cuts that can be made. To succeed, this technique must permeate the entire organization, giving every manager an end-product orientation that makes personnel cost control a "grass roots" movement. This approach uses the concepts of value budgeting which has been shown to be an effective control of the generally unquantifiable performance of supervisory and support personnel.

Each of these cost-control methods as discussed in detail in Exhibit 6. Before applying any of them, a bank should assess where the opportunity lies so that it can select the best procedure, thereby improving its chances of actually capturing the cost-reduction opportunity.

CONCLUSION

A comparative survey provides a useful method of analyzing human resource deployment, benchmarking staffing levels opens participant's eyes and benchmarking provides information which can set priorities for closer examination of efficiency and utilization. A benchmark is never a substitute for detailed analysis, since each bank has its own strategy and market position. It is up to top management to surface these reasons why one bank might depart from the benchmark and to turn a mere display of comparative statistics into a point of departure for effective reduction of personnel expense.