The rise of digital banking, a long-running trend accelerated by the COVID-19 pandemic, could trigger thousands of layoffs and elevate the importance of efficiency as a key metric of banking performance.

Combined with a tough operating environment of low rates and weak loan growth, the digital revolution has created a race to develop best-in-class technology that can win clients, reduce overhead costs and defend traditional banks against a multitude of fintech start-ups. Community banks could be in for a tough fight, facing challenges from both smaller, nimble fintechs and megabanks that are orders of magnitude larger.

As U.S. banks continue to adapt to the increasingly digital environment and search for levers to improve efficiency, headcount may drop dramatically. A May 12 report from Mike Mayo, an analyst with Wells Fargo Securities, estimated U.S. banks could cut up to 200,000 jobs, or 10% of the entire workforce, in the next decade. Most will come from office, branch, call center and corporate staff, Mayo wrote. The Bureau of Labor Statistics estimates that the number of tellers will decline by 15.3% by 2029.

"Banks have no choice but to achieve record efficiency," Mayo said in an interview. "This is a historic crossroads for the use of technology by banks."

As customers increasingly turn to digital channels and U.S. banks continue to shutter branches, the makeup of the U.S. banking workforce is evolving. Roles that are repetitive and manual in nature, such as bank teller positions, are "in danger" going forward, Patrick Luther, vice president and principal of the financial services industry advisory at Ceridian, said in an interview. Some banks have installed interactive teller machines, or ITMs, that allow video tellers to serve multiple locations.

But the evolution of the U.S. banking workforce is a double-edged sword for expenses, experts said. The need for technology-related roles is amplified, which elevates expenses because these roles are much higher paid. The industry aggregate for U.S. banks' salary and benefits expenses was $237.72 billion in 2020, up 34% from $177.55 billion in 2011.

Smaller banks have been less efficient than their larger peers, evidenced by a higher median efficiency ratio — a measure of noninterest expense divided by net interest income and noninterest revenue, meaning lower numbers reflect a more efficient bank. The need to improve efficiency to drive earnings growth has intensified over the past year as the COVID-19 pandemic elevated expenses and shrunk revenue.

Through technology, banks can automate processes, which may reduce headcount, and migrate more customers to digital channels, allowing banks to rethink and reduce their branch networks. The COVID-19 pandemic pushed more customers to digital channels, allowing U.S. banks to shutter a record number of 3,324 branches nationwide in 2020.

Though technology presents several avenues to improve efficiency, the initial expenditure can be costly. In a competitive landscape where mobile offerings have become table stakes, smaller banks with fewer resources face a tougher task.

"Goliath is winning," Mayo said. "The largest banks are better able to deploy their scale for technology and efficiency benefits."

The cost of digitization

Red Bank, N.J.-based OceanFirst Financial Corp. is currently on a journey to digitize the bank to drive greater efficiency. In the past five years, OceanFirst's IT-related expenses have increased 4x, and the bank's staff dedicated to digital banking and IT have increased six-fold, according to Chairman and CEO Christopher Maher. Currently, about 19% of the company's operating expenses are related to technology.

"You're talking a massive increase in direct dollars, another massive increase in headcount," he said in an interview. "In the long run, it's going to be a very positive outcome … The expenses are going up because we're building infrastructure so that expenses can go [back] down."

The investments will improve profitability but communicating the initial increase in expenses to investors can be tough, he said.

"When you look at things in relation, we are a more efficient company than we were five years ago," Maher said. "But when you're telling [investors] that story, it's a challenge."

OceanFirst's efficiency ratio was 58.2% in 2020, down from 63.3% in 2015.

Generally, most investors understand that efficiency improvement initiatives can take time and present elevated up-front costs, Cheryl Pate, a portfolio manager at Angel Oak Capital Advisors, said in an interview.

"What is most important in sort of any investment spend on efficiency improvement initiatives — and what gets the most credit from the market — is having a specific plan outlined with some benchmarks that are expected to be hit by certain time frames," she said.

At OceanFirst's upcoming shareholder meeting in August, Maher plans to communicate the impact of the company's technology investments, branch restructuring initiatives and the recent hiring of 20 commercial bankers and what that means for loan growth.

"When you take the sum of those three messages … you then have an opportunity to set some benchmarks for your investors around margins as well as return on assets, return on equity and kind of where the direction of earnings per share should be going forward," he said.

Maher pointed to OceanFirst's noninterest expense to total assets declining to 1.75% from 2.4% over the past five years as one benchmark the company has used to measure the success of its investments.

The benefits of scale

When it comes to leveraging technology to improve efficiency, scale matters, experts said.

Through organic growth and six whole-bank acquisitions since 2016, OceanFirst has grown to $11.58 billion in total assets at March 31 from $2.58 billion at March 31, 2016. With scale, OceanFirst can better invest in technology, build out a more experienced technology team and develop its own internal processes, Maher said.

At an industry conference on June 3, Bank of America Corp. CEO Brian Moynihan reflected on how technology has impacted the megabank's efficiency. Since he took the helm as CEO in 2010, Bank of America has reduced its headcount by almost 100,000, invested in "higher-paid" employees and remodeled 75% of the bank's branches all while keeping the company's expense base at the same level as 2015, he said.

"That's the efficiency of continuing to digitize your practice," he said. Bank of America's efficiency ratio reached 90.2% in 2011, but by 2018, it was below 60%.

With their massive scale, the largest U.S. banks can invest in the latest technology while also maintaining and expanding their branch footprints to reach more consumers, said Chris Ward, a principal consultant with Informa Financial Intelligence.

"You need to have the scale to be able to do two things at once," he said. "[The larger banks] have quite a big advantage because they can simultaneously afford to maintain a branch network."

Banks with greater than $250 billion in total assets increased their headcount by 9% in the past decade, compared to the industry aggregate of a 2% decline in full-time employees over the same time period.

For smaller banks, maintaining a branch footprint and transforming digitally can be a challenge, making it even more important to identify other areas to cut costs as expenses are driven up by technology investments.

"The large banks are growing faster than the community banks and as they grow ... they are hiring more employees," said Julien Courbe, a lead partner for the financial services advisory practice at PwC. "The community banks have been under much more pressure for profitability."

Though the ongoing digitization of banking can put an initial strain smaller banks' expenses, many see it as an avenue to bolster the community bank business model.

"Technology helps simplify processes, eliminate redundancies in the back side as well as on the front side," Jose Rafael Fernandez, president and CEO of Puerto Rico-based OFG Bancorp, said in an interview. "Time is freed up to do what bankers should be doing, which is helping the communities and helping the customers and helping them achieve their goals."