Financial institutions in emerging markets

can achieve efficiency through innovative

branch formats, extensive outsourcing, and
stripped-down operating processes.

Tomás Elewaut, Patricia Lindenboim, and Damián L. Scokin

The McKinsey Quarterly, 2003 Number 3

To counter stiff competition, banks in the developing world are working hard to get their
costs down. Those capable of using mergers and acquisitions to capture economies of
scale from their staff, IT, and back-office functions usually do so, much like their Western
counterparts. But banks in small emerging markets and in markets with limited M&A
possibilities can’t lower unit costs by these means.

Scale isn’t the only route to cost efficiency in banking, however, and some smaller
institutions in Western countries have used more efficient processes to match or even beat
much bigger competitors. Can banks in other parts of the world copy these state-of-the-art
skills? Gross domestic product per head in emerging markets is much lower, so average
customers generate substantially less income for their banks and are proportionately more
costly to serve. In addition, most banks in emerging markets still process many
transactions (mainly payments) by hand—an expensive undertaking.

Yet Chilean commercial banks have proved that world-class cost efficiency is indeed
possible in emerging markets. With only 15 million inhabitants, Chile is one of Latin
America’s least populous countries, but in 2001 its five biggest banks boasted an average
cost-to-income ratio of 59 percent, far better than the five biggest in Brazil and better even
than much larger banks in the United States (exhibit). Chile’s largest private institutions—
Banco Santander and Banco Santiago (which merged in 2002 and are owned by Spain’s
Santander Central Hispano) and Banco de Chile—have made remarkable gains: they cut
their average cost-to-income ratio from the moderate level of 65.1 percent in 1995 to a
world-class 54.1 percent in 2002, largely by reducing their costs.
Chilean banks are doggedly pursuing cost efficiency through innovative branch formats,
extensive outsourcing, and lean operating processes. These three levers are by no means
unique, but banks in Chile have shown how to adapt them to serve the low-income
segments of emerging markets. To suit local realities, the banks have radically
transformed their traditional branch networks; the new formats include specialized no-frills
offices where they extend high-interest credit to the lower-income market. For basic
transactions, they use Servipag—a bill-payment network that came into existence partly as
a response to a Chilean law obliging banks to provide clients and nonclients alike with
services such as utility-bill payments, tax collection, and check cashing.1 By delegating
these payments to a specialist network with spartan kiosks and basement offices staffed
by clerks who lack full banking qualifications, financial institutions have reduced their
personnel and infrastructure costs. More than 20 percent of all monetary transactions that
were once handled by branch tellers now go through this external channel, at half the
previous expense.

Outsourcing has also proved a powerful solution in dealing with another daunting local
challenge—check processing. Time-consuming and bounce-prone checks, still common in
Latin America as a result of high credit card fees and interest rates, are a nightmare for
back offices. Chilean banks have a major scale disadvantage: they process only some 25
million checks a month as compared, for example, with Brazil’s banks, which process 440
million a month. But by using two check-processing specialists with highly standardized
systems, banks in Chile are moving toward the scale advantage of their Brazilian
counterparts: unit costs have fallen drastically because an outsourcer can handle three to
six times the capacity of any one Chilean bank. Some institutions have outsourced almost
half of their operations, including purchasing, credit card processing, money transport,
data-center management, and software development and maintenance.

The experience of Chile’s banks offers encouragement for small banks in other emerging
markets, where deregulation is inviting increased foreign competition while economic
stability, with its lower interest rates, forces down lending and deposit margins. Because
Chile has been maturing in this fashion for 20 years, its banks as a group have made more
progress controlling their costs than have banks elsewhere in Latin America and in other
emerging markets; in Brazil, for example, double-digit interest rates have allowed the
leading institutions to thrive without having to follow the Chilean example. But as M&A
opportunities dry up in these countries, their big banks will no longer be able to rely solely
on increasing scale to reduce their unit costs. Such banks may soon have to cut their
operational expenses.

Notes:

Tomás Elewaut is an associate principal in and Patricia Lindenboim is an alumnus of McKinsey’s

Buenos Aires office; Damián Scokin is a principal in the Santiago office.

1Servipag—a joint venture of two banks, Banco de Chile and BCI—charges fees to the banks it
serves.

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