Banks: Stubbornly High Interest Rates Call for a New Cost-Cutting Playbook

With interest rates showing no signs of decreasing, Pierre Buhler and Rajeev Aggarwal argue that bank executives must drastically reduce costs. To find a leaner way to operate, they suggest asking three key questions.

As the election nears, the debate over interest rates has become more about politics than policy. However, basic economics tells a simpler story: when inflation remains stubbornly high, interest rates need to be increased further.

In the U.S., as of mid-June, interest rates continue to be stuck at a 23-year high, as the Fed is hesitant to prematurely cut rates. Atlanta Federal Reserve president Rafael Bostic has said he only anticipates one cut this year. He has hinted that people are going to have to get used to a new normal, closer to where rates were in the 1990s and early 2000s than those of the last decade.  While May inflation came in at 3.3%, a slight cooling versus April’s 3.4%, consumer prices remain on an upward inflation trend. U.S. debt also continues to mount at a staggering pace — currently at $34 trillion yet projected to grow by $1 trillion every 100 days.

In the UK interest rates continued to hover at 5.25% despite Bank of England governor Andrew Bailey predicting that they’ll soon be slashed. Is his projection overoptimistic? Inflation has dropped to 3.4%, the lowest in the past two years — yet this figure is still off from the BOE’s summer goal of 2%. The cost of living has also remained high, and gas prices have even slightly increased.

Banks are at the Center of the Storm

In this sustained high interest rate environment, many might see the profitability of banks as a bright spot. However, this success will be short-lived. Persistently high interest rates increase the default rate, and those defaults will offset any increased margin on loans. As credit risk rises, default will become more prevalent. The commercial real estate crisis has also seen little relief — office vacancy rates remain historically high, while rising costs and high interest rates discourage investment.

Impressive first quarter earnings by Wells Fargo, Goldman Sachs and Citigroup, may give false hope to those betting on the sustained revival of American banks. These banks have not solved their core issue: the increasing cost of retaining funds. JPMorgan might be the lone exception — savvy risk management decisions and their sheer scale make the banking giant’s rebound seem more sustainable.

When There’s No More Fat to Trim

Stubborn inflation coupled with projected market volatility should encourage organizations to drastically cut costs. Traditional methods have already been exhausted — everything has already been outsourced and offshored. To operate leaner, executives will need to address three key questions:

• Core Capabilities: Which of our current businesses, products and geographies are dilutive and therefore not worth being strategic priorities?
• Structure: Once core capabilities are established, how can we restructure this core to increase synergy and efficiency?
• BAU Efficiency: How do we drive value from third party contracts? Are there processes that can be standardized and streamlined, creating clear roles to eliminate duplication? What tech investments are required to automate rapidly, while embedding clear performance metrics and KPIs?

A year ago, the promise of cost-saving generative AI meant companies were reluctant to tighten their belts. Now we see that these projections were either unrealistic or years away. There is now a pressing need for a new cost-cutting playbook.

About the Authors

Pierre Buhler and Rajeev Aggarwal are Managing Directors in the Financial Services practice of global consultancy SSA & Company, where they bring decades of experience working in the banking and technology sectors. They can be reached respectively at PBuhler@ssaandco.com and  raggarwal@ssaandco.com.