Over the past decade, US banks have improved their productivity by about 1 percent a year. They have done so mainly through short sharp shocks: one-off initiatives focused on cutting costs and reducing headcount (Exhibit 1). Though unpleasant, these exercises proved effective in boosting earnings, and hence stock price. Once they were completed, however, life usually returned to normal. Productivity often stagnated or even slid back until the next wave of cost cuts.

So while substantial costs have been taken out of the US banking system, scope remains to raise productivity further; indeed, much of the merger and acquisition activity of the past two years has been based on this premise. Though variations in business mix justify some structural differences in operating costs, the size of the gap between the absolute efficiency and improvement rates of the best-performing banks and those of the rest of the pack gives some indication of the potential (Exhibit 2).

How then should banks go about capturing the extra productivity? The answer is: by looking at how manufacturers do it. Rates of improvement recorded by world-class manufacturing companies far exceed those attained by banks (Exhibit 3). Much of the reason can be found in...