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The Race For Banks To Cut Costs: Standard Chartered plc & HSBC Holdings plc

Asia-focused banks Standard Chartered (LSE: STAN) and HSBC (LSE: HSBA) have both announced ambitious plans to cut costs and restore profitability. Slowing economic growth in emerging markets and concerns about rising levels of loan losses have meant that improving cost efficiency has become even more important.

Both banks have bloated cost structures but HSBC’s is in worse shape, as the bank’s cost to income ratio was 67.3% in 2014. This compares to Standard Chartered’s cost to income ratio of 60.2%. But with declining revenues and rising loan impairments at Standard Chartered, its cost efficiency is likely to worsen significantly over the next few years.

Cost reduction plans

HSBC had tried to reduce costs by retreating from peripheral markets and scaling back its retail banking ambitions, but overall costs just seem to keep on rising. The bank will find it difficult to meet its mid-50s cost to income target, because the bank’s size and complexity has added almost $1 billion in additional annual compliance costs.

The bank’s new cost-cutting drive intends to be more ambitious than in the past. It is aiming for a reduction of 25,000 jobs, a cut in the size of its investment bank and a sale of its operations in Brazil and Turkey. Together, this should bring in cost savings of about $5 billion annually, and will cost the bank up to $5 billion over the next two years to implement the plan.

Standard Chartered plans to cut costs by $1.8 billion over the next three years, by exiting non-core businesses and introducing more standardisation and automation into its processes. In addition, CEO Bill Winters unveiled a new simplified organisational structure, which will see himself and regional CEOs assume more direct responsibility.

But, of greater concern had been the rapid rise in loan loss provisions over the past year… and loan losses could still rise further, because of its sizeable commodities lending portfolio. Loan impairments rose 80 percent to $476 million in the first quarter, from $265 million last year. This has fuelled concerns about the bank’s capital adequacy and whether a rights issue could be on the table.

In the long term, HSBC and Standard Chartered should benefit massively from their cost-cutting plans. But, in the short term, earnings is likely to deteriorate further, as new sources of revenue should not be able to offset losses from the disposal of non-core businesses. Furthermore, slowing emerging markets only compound to the problems of weak profitability in the near term.

Changes in the bank levy

One of the banks’ biggest costs has been the UK bank levy; and on this front, things will at least begin to improve. Chancellor George Osborne announced changes to the bank levy in the Budget this month. The levy would be gradually cut from 0.21% to 0.1% by 2021, and it will only apply to each bank’s UK operations from 2021 onwards. The loss in revenue to the Treasury will be offset by the introduction of a new 8% tax surcharge on bank profits, which will take effect from 1 January 2016.

Although this will be a trade-off of more short term pain for long term gain, HSBC and Standard Chartered are now less likely to move their headquarters out of the UK. By 2021, HSBC is expected to save £700 million annually, whilst Standard Chartered should save around £350 million.

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Jack Tang has no position in any shares mentioned. The Motley Fool UK has recommended HSBC Holdings. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.