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 starting to become clearer. U.S. banks are finally beginning to see a payoff as evidenced by improved efficiency ratios, streamlined back offices and smaller workforces, certain research analysts say.
Skeptics counter that other factors including consolidation and stricter risk management are at work, too, in strengthening efficiencies and returns. The relative impact of the different forces is hard to calculate, they say, and the analysis varies based on a bank's size.
Wells Fargo Securities analysts are decidedly in the pro-tech camp. Banks' past 10 years of tech spending should help them improve their efficiency ratios — or noninterest expenses divided by net revenue — from an average of 62% in 2021 to 56% in 2022 and 55% in 2023, they wrote in a recent research note.
"Unlike prior periods where banks needed to add headcount 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 to the bottom line (before provisions)," the note said.
Mike Mayo, managing director and head of U.S. large-cap-bank research at Wells Fargo Securities, said in an interview that the "promise of technology" is playing out in a measurable way like no other time in his four decades following the industry.
"Technology is allowing banks to add on more revenues without the same level of bankers, paperwork, manual intervention and management layers," he said. "You're likely to see the acceleration of revenues in the third, fourth and following quarters without much increase in headcount."
Some other analysts agree. Stephen Biggar, director of financial services research at Argus Research, said in an interview that banks seem to be reaping long-awaited returns on their tech spending, "with the caveat that we don't have a lot of transparency" into specific investments and how they have performed.
The hoped-for benefits are partly a result of technology getting better at doing the work of humans and partly of rising interest rates, which will strengthen loan revenue.
"Banks benefit both from the way they deploy new technology and the environment in which they're doing so," Mayo said. "What's underappreciated is the ability of technology to help banks layer on additional revenues at lower marginal cost."
Technology should help banks reduce their branch counts by 25%, increase customer service automation by 33%, reduce back-office expenses by 40% and reduce their employee bases 5% to 25%, Wells Fargo Securities analysts said.
"After two decades of incremental improvement, 2020 and 2021 saw a step change in efficiency per employee in terms of deposits, with the bank industry increasing deposits by 21% per employee in 2020 and another 6% in 2021 (inflation adjusted)," they wrote. "That sort of growth is unprecedented in U.S. banking history."
Not everyone agrees with the premise. Chris Kotowski, managing director at Oppenheimer, estimates large banks' average efficiency ratio at 62.7% for 2021 and forecasts it to be 64.6% for 2022 and 61.9% for 2023. He considers 60% a good ratio.
Kotowski noted that large 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 at, 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 you the biggest differentiating factor is not so much that JPMorgan has been more clever 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 credit the fact that there's a lot of consolidation happening," he said.
For instance, 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 mentioned technology spending as a major impetus for the deal," Biggar said. "It was right up there with branch consolidation and other places they expected to get either merger expense or revenue synergies."
Kotowski and Biggar also noted that it's hard to tell how well any technology investment is performing within a bank.
"As an outside analyst, you won't know whether that particular database was a good expenditure or whether that computer system was a good expenditure or whether they spent too much money on some systems integration project," Kotowski said. "You won't know that any more than you'll know whether it was a good idea for Bank of America to build a branch at 84th Street and Broadway."
Not all banks will feel the tech tailwind
The anticipated tech returns are not expected across the board. There is a clear and growing technology gap between the top five banks and the smaller credit unions and banks, noted Alex Jimenez, managing principal in financial services consulting at EPAM Systems.
"One driver of this gap is the commitment to modernize technology and apply these capabilities to the organization, though it is not the only factor," Jimenez said. "Changes in strategy, business models and culture have enabled these larger banks to become digital leaders."
It's the largest banks that seem best poised to generate returns from their tech spending.
"It's hard for us to find a large-cap bank that's not benefiting from improving efficiency related to technology," Mayo said. "The real difference comes in how much of the savings are getting reinvested, and how far is a bank looking to take its technology? So on one extreme is JPMorgan Chase, which is reinvesting the benefits of the last five to 10 years, and now spending more money than they've ever spent in their history on technology."
Biggar agreed that big banks are the ones investing heavily in technology and starting to enjoy the results.
"It's the large banks that are spending so much, throwing a lot of darts right at the wall," he said. "They're going to hit their mark much more often, relative to the smaller banks, which are basically just blocking and tackling. They're not spending the billions on trying to compete with fintech and mobile app technology."
Large companies can leverage tech spending over a much broader base, Biggar noted.
"JPMorgan Chase certainly gets massive leverage from the same dollar of tech spending as does a bank half its size or a quarter of its size in assets," he said.
Among the largest banks, it's hard to say which are getting the greater returns on their tech 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 move beyond the fray."
Bank of America has led the industry in measuring, monitoring and managing digital banking investments, engagement and results, Mayo said.
"Bank of America has gained deposits, they've improved efficiency, and they've positioned themselves to generate more revenues through digital means," Mayo said. The bank's virtual assistant, Erica, big data, rewards and automated service have helped it provide better service at lower cost than in the past, he 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 also stands to benefit from its $12 billion annual tech spend, Mayo said.
The technologies making a difference
During JPMorgan Chase's second-quarter earnings call, Mayo asked CEO Jamie Dimon how technology might help the bank get through a recession. Dimon replied 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 down $100 million to $200 million," Dimon said. "Volume is way up. That's a huge benefit."
Advances in AI, big data, 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 40 years or more, and of deploying more forward-looking technology like digital banking, AI, machine learning, big data and the cloud.
"Every large bank reports savings in the back office, such as by using AI to deflect phone calls, streamlining loan processing (commercial, auto, mortgage, card), eliminating more of the middle office, and automating areas such as post-trade processing," the Wells Fargo Securities analysts wrote in their note.
Customers' demands for convenience have helped banks become more efficient over the past 20 years, too, Biggar noted, with greater use of ATMs, mobile check deposit, online and mobile banking.
"Banks have obviously spent tremendously on these convenience factors that have saved them on branch expenses," he said, noting that banks are still opening new branches in some places.
Mayo expects headcount to decline in the banking industry by 5% to 20% over the next decade. For instance, as the number of branches shrinks, there will be fewer tellers. As more loans are automated, there will be fewer people needed to input and verify data. As more applications are put in the cloud, there will be fewer data-center technicians 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 market share of lower-tiered customers, they recoup in better efficiency," Mayo said. "So technology is enabling what should be record efficiency in the banking industry over the next five years."
