Centralized or Decentralized Bank Management?

Centralized or decentralized bank organizational structure

Once you hit about $500mm in total asset size, your bank should be asking what organizational architecture it wants – centralized or decentralized. A smart bank lays the ground work at $500mm, and then by $750mm can start to reap the benefits of design. By $3B, the bank should be fully leveraging the results of the decision. In banking, success has been had both ways. We can point to many banks that centralize management, credit, marketing and many other functions. These banks have successfully gained efficiency and have produced coordinated strategies to run circles around the competition. All this sounds good, except at CenterState, we don’t believe it. In this post, we make the argument that all banks should operate in a decentralized manner unless certain conditions are met.


The Chipotle Experience


The best case for organizational centralization can be found in a burrito. Opening in 1993, Steve Ells, Chipotle’s CEO grew across its home Denver area. Having a hit on his hands, he quickly laid plans to franchise the concept. Except management soon noticed that the salsa in Denver didn’t taste the same as the salsa in Texas despite everyone using the same recipe.


It turned out that locally produced salsa varied greatly, and while a hallmark of the brand, caused an uneven customer experience. After convening a strategy meeting, Chipotle killed the franchise idea and determined that going forward, all stores were to be owned and controlled by corporate. That structure was tested in February of 2016 with a consistent report of the norovirus. It was only through this centralized structure that the chain was able to react quickly, inspect, modify procedures, market and train as quickly and efficiently as it did.


We know that centralization has clearly proven benefits, but we are still not believers.


Comparison of Centralized and Decentralized Bank


Why We Believe in a Decentralized Bank


At CenterState, being locally driven is our first core value. When we were small, we used to be centralized. It was nice having everyone together. The problem was that we could not sustain it. As we acquired, in particular, we took in some good people that did not want to move. As a result, we are organizationally all over the place. The head of marketing is in a branch; our chief lending officer is in another branch; and our CEO, CCO and COO, are all in headquarters. And, that is not exactly true because our COO and CEO are rarely actually in headquarters, they are traveling around.


Honestly, from an employee standpoint, it can be frustrating – and inefficient.  


That said, we probably have a better feel for the market and have better quality staff compared to our centralized competition. Thus, it comes down to a tradeoff, but it comes down to a tradeoff that will tilt more in our favor in the future. Building our organization around our people, creating an organization similar to Bank B below and getting our talent, including our CEO and COO into the field with our customers and staff is a critical cultural element.  


Organizational Structure


While we have discussed before (HERE) about how decentralized “Action Teams,” similar to Bank B above, allows us to organize more around our employees and customers (the top two most important assets of our bank), our point today is that this concept should be applied to the entire organization.


The Biggest Problem with Centralization


A bank’s most valuable asset is its people. This isn’t just corporate culture pablum. For banks that track organizational profitability, a good loan can produce an 18% risk-adjusted return, a good deposit can produce a 100% return, a good customer can produce a 300% return, but a good employee can be 1,100% or better.  The standard deviation, or difference, in performance between an average employee and a top performing employee, is almost three times that of a branch. Good employees can and do make a difference in bank performance on a daily basis. It, therefore, stands to reason that you want to attract the best employees possible. Banks that are geographically and operationally constrained due to centralization are going to have a harder time attracting the talent they need to be competitive in the future.


The Myth of Efficiency


To get a quality employee to move to your headquarters often requires a higher compensation package. This is an example of the myth of economies of scale. While seemingly inefficient, our decentralized structure is often more efficient. In addition to employee compensation, consider certain factors such as office space. Being decentralized gives us more operational flexibility. Banks in large metro areas usually always find that it is more cost efficient moving credit and operations to lower cost locations away from management. This is usually the first step towards decentralization. 


In this day and age, unless you are just going to stay small and focus on a single geographical area, centralization isn’t a suitable option. We can overcome problems in communication and cost efficiency that centralization often solves, but we can’t overcome not having the best talent.


Technology has been a big enabler of decentralization, a trend that will continue. CRM, loan processing, profitability, risk management and cloud-based operational system have helped permit the benefits of centralization while supporting a decentralized structure. Communication tools such as wide area text, Slack or video conferencing have helped increase the efficiency of communication allowing for the spread of information in a decentralized organization as efficiently as in a centralized organization.


Technology will continue to improve the performance of a decentralized organization, and then there is resiliency.


The Rise of Resiliency


A centralized organization has greater risk. No bank argues that it needs multiple, geographically dispersed nodes in its IT infrastructure. In similar fashion, a bank needs multiple organizational nodes in its ideas as well.


A centralized structure runs the risk of getting caught in group think. Ideas tend to converge, creativity is often stifled, products become more generic. Having lenders, credit underwriters and marketers, for example, out in various areas allows for a more diverse point of view. Having multiple outside firms handling the same tasks for different divisions or areas while sometimes is less efficient, it does permit a certain level of redundancy which can make the organization more diverse and resilient. We know several banks that use multiple marketing firms, lawyers and event planners just to make all perform better.


When to Centralize


Of course, sometimes, centralization is best. These areas are becoming few, but they do exist. We use this three-part test to decide when to centralize a function. Answering yes, to any one of the three questions below would lead us to primarily consider centralizing the function:

  • Is centralization required by the regulators or laws?
  • Can we gain 15% or more efficiencies by centralizing the function?
  • Can we materially reduce risk by centralizing the function?

 To our point above, technology is making many of these points clear “Nos.” It used to be that having a central place to access and manage loan files was highly suggested from a regulatory and efficiency standpoint. Now, with all electronic files and cloud-based storage, loan files can be efficiently accessed anywhere thereby reducing risk. In similar fashion, most banks used to only have a single secured wire room. Now, that is no longer the case. While these three questions still govern our organizational structure decision, it is rare we get a “yes” any more.


Putting This into Action


The decision to act as a centralized or decentralized organization should be based on many factors and should be made with forethought. This single decision deeply impacts a bank’s short- and long-term success. While performance can be had both ways, it is our thesis that a decentralized bank allows for the gathering of higher quality employees, presents better cost efficiencies, allows for being more market driven and structures a more resilient organization.


Similar to what the Navy SEAL Teams, Nordstrom’s and the Ritz-Carlton have found, having a decentralized organization is ideal as long as you can assimilate information and maintain some control over standards. This means that the battle between centralized and decentralized is often a false dichotomy. There is a spectrum, and while we try to remain decentralized whenever possible, smaller banks may gain more from centralization. Use the three tests above and consider how the future will play out. Information and change will only increase in speed and a bank that organizes itself now, in a decentralized fashion will be more adaptable in the future.