In studying explanatory and response variables, statistics instructs us to not overlook the lurking variable. This is one that isn’t being studied but could influence the relationship between variables that are being considered.
Take the recent reductions in expense and staff at banking institutions.
It would seem that, with billions of dollars in reductions in expense and staff at financial institutions, cost-income ratios should be on the mend and should be showing substantial cuts. Furthermore, the scale efficiencies that many of the larger banks recently sought through merger and acquisitions internally should have driven down the cost-income ratios.
But data from the St. Louis Federal Reserve suggests that, while there was a downward trend, it wasn’t really substantial over the past two decades. In fact, over the last decade it has trended upward (per the Deutsche Bank report on Bank Performance).
While the various expense reduction programs have helped these institutions survive the “existential threat,” European Central Bank (ECB) estimates that as it pertains to branch rationalization and headcount reduction, the programs yielded mixed results.
In fact, when viewed as a percentage of total assets, it appears that cost shedding has not kept up with asset shedding at these banks. Furthermore, with staff costs being the largest proportion of total costs, it appears that the layoffs and declines in staff compensation didn’t really result in any significant cost savings.
Thus, according to The Banker, “the hard work on this has hardly begun.”
Rather than taking out a layer here and there, banks need to rethink their business model. It is indeed this variable that needs to be looked at deeply as the differentiation vs. commoditization debate will further heat up in the coming days, forcing a discussion on cost at a scale that has not happened before.
As always, appreciate your thoughts!