Academic journal article ABA Banking Journal

Efficiency Ratios Take a Hit

Academic journal article ABA Banking Journal

Efficiency Ratios Take a Hit

Article excerpt

Relied upon by investors and internal decision makers alike, efficiency ratios can prove a powerful tool for evaluating banks. A simple ratio comprised of expense and revenue components, it provides insight that can be used to evaluate the overhead structure of a financial institution. Simply put, an increasing efficiency ratio over time means that an institution is losing a larger percentage of its income to expenses; a decreasing ratio means a bank is learning to operate more effectively.

As can be seen in the chart, in 2007, the mean efficiency ratio for all public banks and thrifts increased for the second year in a row, reaching 67.73%, its highest mean in eight years. Public banks and thrifts saw total expenses grow 23.3% from 2006 to 2007, while operating revenue grew only 5.31%. This is a drastic change from 2006, when total expense and operating revenue grew 10.30% and 10.54%, respectively. In an environment where expenses doubled their year-over-year growth from one year to another and revenue growth has stalled, banks will have to adapt quickly or face the prospect of operating losses.

So what has to give? Banks will have to reduce their expenses in any way possible: cutting dividends, shuttering or divesting lines of business and selling off assets. …

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