Reductions in workforce numbers have been Wall Street’s inevitable, and understandable, response to the global credit crunch. But new McKinsey research shows that the untapped opportunity to cut noncompensation costs is also considerable—possibly amounting to more than $2 billion in recurring savings for some investment banks. What’s more, our analysis suggests that executives can embark on this additional belt tightening without harming a bank’s culture and morale.

Banks routinely use a variety of metrics to monitor their expenses. Operating costs as a percentage of revenues is a helpful measure in more stable times. The absolute value of costs and their growth rate are also widely watched. However, there is a strong correlation between compensation costs and revenues: when the market is up, compensation swells; when the market is down, it dwindles. That often masks underlying trends in noncompensation expenses—trends that get lost in the totals. As a result, when banks compare themselves with their peers, they may miss important differences.

We believe that the best indicator, though one used less widely than the others, is noncompensation costs per head count. This measure largely eliminates distortions created by revenue volatility and growth, and it facilitates peer-to-peer comparisons. Applying the per-head-count ratio neutralizes the effects of bank expansions or contractions and of one-time investments, which fuel one-off jumps and falls in total bank costs. For the purposes of our survey, we selected eight financial-services institutions with major investment-banking operations in the United States—investment-banking divisions of universal banks, broker/dealer legacies, and regional powerhouse banks—and benchmarked their noncompensation costs over the past three years.¹ Our data came from public sources such as 10-K filings, bank Web sites, and earnings reports. The reported head count data for the investment banks in our sample came from banks that report front office heads only and those that add their share of middle- and back-office staff. The results of the analysis were almost the same for both kinds of data.

The results suggest that the magnitude of the prize may range from $400 million to $2 billion for the institutions with the most savings opportunities, represented by the bottom three quartiles (Exhibit 1). Moreover, the difference in noncompensation costs per head count between the top- and bottom-quartile banks is significant.

Certain investment banks appear to have become bloated during the good times. From 2005 to 2007, only three of those in our sample managed to keep the compound annual growth rate (CAGR) of their noncompensation costs below the rate of their revenue growth (Exhibit 2). At the others, noncompensation costs either surpassed or kept pace with revenue growth. In addition, at all but three banks, CAGRs for noncompensation costs were in the double digits.

When implementing cost-savings programs, we find, bank executives are often cautious because they fear an outcry from employees, especially if they have already eliminated a large portion of their operating costs through a workforce reduction. The good news is that initiatives to curb expenditures need not be extremely demoralizing to frontline employees. While programs aimed at reducing noncompensation costs have long been associated with cuts in travel and entertainment and in employee benefits, these are not the only opportunities. Indeed, our breakdown shows that 80 percent of fixed costs have minimal or no impact on a bank’s employees or culture (Exhibit 3). Launching initiatives that target these areas, we estimate, could in many cases produce most of the noncompensation savings that banks aim to achieve while reducing the possibility of targeting areas that could damage employee morale.

Our experience indicates that data, printing, supplies, delivery, and professional services usually yield the fastest results; restructuring real estate and IT spending may take longer but generate much larger savings.

The potential financial benefits from cost-savings programs—benefits that equal some banks’ annual earnings—are difficult to ignore. But identifying the scale of the opportunity is only a first step. In our experience, cost initiatives can reach their savings targets within 3 to 18 months of launch, but implementing a sustainable cost program may require years of disciplined effort.