Banks have been pouring billions of dollars into technology projects for a decade, raising at least two lingering questions: Have the investments been worth it? How do you know?
In the eyes of some observers, the answers are beginning to be clearer. US banks are finally beginning to see a payoff, as evidenced by improved efficiency ratios, streamlined back offices and a smaller workforce, some research analysts say.
Skeptics counter that other factors, including consolidation and tighter risk management, are also working to strengthen efficiencies and returns. The relative impact of the different forces is difficult to calculate, they say, and the analysis varies depending on the size of the bank.
Wells Fargo Securities analysts are decidedly in favor of the technology. The past 10 years of technology spending by banks should help them improve their efficiency ratios, or non-interest expenses divided by net income, from an average of 62% in 2021 to 56% in 2022 and 55% in 2023, they wrote in a recent research note. .
“Unlike previous periods when banks needed to add staff or infrastructure to support revenue growth, the next two years should see banks drop 50 cents to 80 cents of every new dollar of revenue in bottom line.” final (before provisions),” the note read.
Mike Mayo, managing director and head of US large-cap bank research at Wells Fargo Securities, said in an interview that the “promise of technology” is being fulfilled in a measurable way like never before in his four decades following the industry.
“Technology is allowing banks to add more revenue without the same level of bankers, paperwork, manual intervention and layers of management,” he said. “You’re likely to see revenue acceleration in the third, fourth and subsequent quarters without a big increase in headcount.”
Some other analysts agree. Stephen Biggar, director of financial services research at Argus Research, said in an interview that banks appear to be reaping the long-awaited benefits from their technology spending, “except that we don’t have a lot of transparency” on specific investments and how they are being spent. have played.
The expected benefits are partly the result of technology improving to do the work of humans and partly from rising interest rates, which will strengthen loan revenues.
“Banks benefit from both the way they implement new technology and the environment in which they do it,” Mayo said. “What is underestimated is the ability of technology to help banks accumulate additional revenue at a lower marginal cost.”
The technology should help banks reduce the number of branches by 25%, increase customer service automation by 33%, reduce administrative expenses by 40%, and reduce their employee base by 5-10%. 25%, analysts at Wells Fargo Securities said.
“After two decades of incremental improvement, 2020 and 2021 saw a step change in efficiency per employee in terms of deposits, with the banking industry increasing deposits by 21% per employee in 2020 and another 6% in 2021 (adjusted for inflation),” they said. wrote. “That kind of growth is unprecedented in US banking history.”
Not everyone agrees with the premise. Chris Kotowski, managing director of Oppenheimer, estimates that the average efficiency ratio of large banks is 62.7% by 2021 and forecasts that it will be 64.6% by 2022 and 61.9% by 2023. He believes that the 60% is a good rate.
Kotowski pointed out that the big banks have been generating consistent levels of return on equity of 13% to 15%. Investment in technology is one factor in that, but others include economies of scale, investments in people, marketing expenses, and better risk management.
“If you look, why does JPMorgan Chase have a 17% return on equity and Bank of America a 15% return on equity and Citibank only a 10% return on equity? I bet the biggest differentiating factor isn’t it’s so much that JPMorgan has been smarter about how they’ve spent their technology dollars,” Kotowski said in an interview. “It’s that JPMorgan has had better risk management and better customer density.”
Biggar also credits technology for some of the efficiency improvements banks have seen. “But I would also acknowledge the fact that there is a lot of consolidation going on,” he said.
For example, the merger of SunTrust and BB&T into Truist Financial led to a markedly improved efficiency ratio, he said.
“When they announced this merger in early 2019, they cited technology spending as a big driver for the deal,” Biggar said. “It was right up there with branch consolidations and other places where they were hoping to get merger revenue or expense synergies.”
Kotowski and Biggar also noted that it’s hard to know how well any technology investment is performing within a bank.
“As an outside analyst, you won’t know if that particular database was a good expense or if that computer system was a good expense or if they spent too much money on some system integration project,” Kotowski said. “You won’t know that any more than you will if it was a good idea for Bank of America to build a branch at 84th Street and Broadway.”
Not all banks will feel the wind behind technology
Anticipated technology returns are not expected across the board. There is a clear and growing technology gap between the top five banks and credit unions and smaller banks, said Alex Jiménez, senior manager of financial services consulting at EPAM Systems.
“One driver of this gap is a commitment to modernizing technology and applying these capabilities to the organization, although it’s not the only factor,” Jimenez said. “Changes in strategy, business models and culture have enabled these largest banks to become digital leaders.”
It is the larger banks that seem best poised to generate returns from their technology spending.
“It’s hard for us to find a large-cap bank that doesn’t benefit from technology-related efficiency gains,” Mayo said. “The real difference is how much of the savings is reinvested and how far a bank intends to take its technology. So at one extreme is JPMorgan Chase, which is reinvesting profits from the last five to 10 years, and now spending more money than they have ever spent in their history on technology.
Biggar agreed that the big banks are the ones that invest heavily in technology and begin to enjoy the results.
“It’s the big banks that are spending so much, throwing a lot of darts right into the wall,” he said. “They’re going to hit the bullseye much more often, compared to smaller banks, which are basically just blocking and boarding. They’re not spending billions trying to compete with fintech and mobile app technology.”
Large companies can leverage technology spending on a much broader basis, Biggar noted.
“JPMorgan Chase certainly gets massive leverage from the same dollar of technology spending as a bank half its size or a quarter its size in assets,” he said.
Among the largest banks, it’s hard to say which are getting the biggest returns on their technology investments, Biggar said.
JPMorgan Chase and Bank of America “are both attacking it in similar ways and both have to spend to keep up,” he said. “And I think you’ll find some winning technologies like Erica that go beyond the fray.”
Bank of America has led the industry in measuring, tracking and managing digital banking investments, engagement and results, Mayo said.
“Bank of America has gained deposits, improved efficiency and positioned itself to generate more revenue through digital means,” Mayo said. The bank’s virtual assistant, Erica, big data, rewards and automated service have helped it provide better service at a lower cost than in the past, she said.
“So even though Chase spends more, I think Bank of America is reaping more benefits because its digital banking is superior,” Mayo said.
But JPMorgan Chase will also benefit from its $12 billion annual technology spending, Mayo said.
The technologies that make the difference
During JPMorgan Chase’s second-quarter earnings call, Mayo asked CEO Jamie Dimon how technology could help the bank weather a recession. Dimon responded that artificial intelligence, “which we spend a lot of money on,” would help.
“We spent $100 million building certain risk and fraud systems so that when we process payments on the consumer side, losses are reduced from $100 million to $200 million,” Dimon said. “Volume is up a lot. That’s a huge benefit.”
Advances in artificial intelligence, big data, the cloud, digital banking, electronic payments, faster processing and process governance are helping banks get more work done with fewer people, Mayo said. It’s a combination of modernizing legacy systems, data centers, applications, and other infrastructure that has been around for 40 years or more, and implementing more advanced technology like digital banking, AI, machine learning, big data, and the cloud.
“All the big banks report savings in the back office, such as using AI to divert phone calls, simplifying loan processing (commercial, auto, mortgage, cards), eliminating more of the back office, and automating areas like post-processing.” to trading.” Wells Fargo Securities analysts wrote in their note.
Customer demands for convenience have also helped banks become more efficient over the past 20 years, Biggar noted, with increased use of ATMs, mobile check deposits, online and mobile banking.
“Obviously, banks have spent a lot on these convenience factors that have saved them branch expenses,” he said, noting that banks are still opening new branches in some locations.
Mayo expects headcount to decline in the banking industry by 5% to 20% over the next decade. For example, as the number of branches is reduced, there will be fewer tellers. As more loans become automated, fewer people will be needed to enter and verify data. As more applications are placed in the cloud, fewer data center technicians will be needed.
Mayo said the increased competition banks face from fintechs such as online mortgage lenders, challenger banks and personal finance app providers is not a serious threat.
“What banks give up in lower-tier customer market share, they get back more efficiently,” Mayo said. “So the technology is enabling what should be record efficiencies in the banking industry over the next five years.”