When we tell banks they need to get to a 35% efficiency ratio to be competitive in the future they look at us like we are crazier than an outhouse rat. Let’s set the branch debate aside (the largest functional cost area) as that is basically a philosophical argument. Let’s just look at your next largest functional cost – loan processing. We get challenged all the time by banks telling us they are “already at full capacity” and “we are already lean.” We point out that there is a difference between being at full capacity and being at optimal productivity. If you want to move to optimal capacity, one path is to adopt a Lean Six Sigma methodology.
There are approximately 40+ community banks that have used either Lean or Six Sigma to gain productivity and almost all of them have reported at least some level of success. Anecdotally, banks report savings of between 20% and 40% in their reengineered loan processing and 70% is not out of the question.
What Is Lean Six Sigma
Forget the belts, the acronyms and the toolkits, both the Lean methodology and the Six Sigma approach look to cut waste from a process. While Lean focuses on waste derived from unnecessary steps or analysis, Six Sigma asserts that inefficient loan processing is a result of variations within a set loan process. The reality is that banks are notoriously poor at formalizing and adhering to a set loan processing methodology so the reality is a combination of both disciplines work best when applied to banking, hence, we use the term Lean Six Sigma.
Lean Six Sigma boils down to taking a methodical approach to the process of “manufacturing” credit with a goal of systemically removing waste in the form of underutilization, errors, extra processing, unnecessary analysis, non-productive approvals and underutilized talent.
Do You Have Inefficiencies?
For the next three months, record the time and effort expended on processing every credit. Chances are when you look at the result; you see a wide dispersion in the time it takes to process each loan. This is the first sign that improvement is needed. Banks that have done this usually come up with a variety of rationalizations – their loan officer went on vacation, the borrower was delayed in getting in her financials or December is a busy time so processing took longer. This is the second sign that improvement is needed.
If you now take your loan processing data and correlate that to risk and complexity of the credit, you should have a fairly strong correlation. That is to say, you spend most of your resources not on the largest credits, but on the riskiest credits. If you aren’t correlated to risk, then that is the third sign Lean Six Sigma can help.
Finally, if your bank performs worse than industry benchmarks or peers, that is the final sign that you may have inefficiencies. Peer metrics come in a variety of flavors and vary according to loan type and application process but for example, typical peer data for commercial real estate processing looks something like this:
- Time expended per application: 22 hours
- Loan Applications Processed Per Month per Person: 5
- Average Turn Around Time Per Loan Application: 15 days
- Loan Applications to Closing Ratio: 70%
Lean Six Sigma Applied To The Loan Process
While we all have problems in our loan processing, Lean Six Sigma banks try to fix the problems in a systematic way. As the famous risk practitioner Gordon Graham said, “If it is predictable, it is preventable.” Lean Six Sigma would look at each delay and then try to organize a solution.
If the issue is vacations, backlogs or bottlenecks, a solution might be to create centralized “work cells” with cross-trained personnel that can fill in for other members. Each cell might have an outsourced solution so that a variable cost processing structure can be leveraged in times of heavy workflow. A process might be put in place where loan files are rotated to other areas or branches. Realignment of teams with a load balancing process is said to increase productivity by 15%.
Then there is the process itself. Entering loan information digitally, then printing the file out only to sign, amend with other information and then scan in again is fairly common. Requiring three sign off approvals where two will do is another classic problem that is common to many banks. Of course, process issues usually stems by treating all loans the same or according to size instead of risk. Streamlining the processes and making so that risk and effort are correlated can usually save banks 25% in processing cost and time.
Finally, the granddaddy of all loan processing savings comes from the collection, analysis and presentation of loan application data. On average, Lean Six Sigma banks have found that 30% of their collected loan information results in no actionable decisions. Giving a narrative of a borrower’s financial position is worthless if it is the same as the numerical version. It also doesn’t matter if the borrower is married, how the client came to have a relationship with the bank, other banking relationships or how historic loans were structured. Conversely, often banks leave out or bury some crucial data points (such as industry analysis or rate shocks) pertinent to an accurate credit decision.
Granted some of the information is interesting and may be important to marketing or profitability, but only slows down the credit review process. If you are not using the information to make a credit decision, put the data in the CRM so you can leverage for other uses.
Narratives should be there to explain the numbers not repeat them. The average credit memo usually can handle more checkboxes, numerical inputs, automatically generated graphs and risk alerts. Formats need to be standardized and flexible depending on the risk. By way of example, the SmartBiz SBA product has an application that expands and contracts according to risk. This ensures that the detail and analysis of information is aligned with the probability of default and that every bit of information results in an action.
Restructuring how and what information is collected, analyzed and presented can save a bank 35% in processing time.
If you are looking to enhance the customer experience, cut credit processing costs, speed performance and reduce errors, looking at loan production through the lens of Lean Six Sigma may be the key to bringing your efficiency ratio below 50%. Lean Six Sigma can be a huge competitive advantage and can help your bank simplify and prioritize what is important. Lean Six Sigma isn’t for every bank, but the concepts apply to every bank that wants to improve performance.
Submitted by Chris Nichols on December 17, 2014