What’s the importance of efficiency ratio?
Efficiency ratio is one of the most important operational ratios in the banking sector. It’s formulated as noninterest expenses divided by revenues. It essentially measures operational expenses such as salaries and sales expenses. It’s a quick, easy, and intuitive measure of the ability of a bank to turn its resources into revenue. It goes without saying that the lower the ratio, the better for a bank. A decrease in efficiency ratio generally implies either an increase in revenues, a decrease in costs, or a higher rate of revenue increases than costs.
Better banks continue to get more efficient in 2014
In 2014, the banking sector saw increasing efficiency, which saw the long-term trend of efficiency ratios declining. In general, bigger and better managed banks continued to become more nimble. Among the big four banks, Wells Fargo (WFC) had the best efficiency ratio underlining its focus on operational improvement. Wells Fargo was followed by Citigroup (C), Bank of America (BAC) and JPMorgan (JPM). Among the next tier of banks, US Bank, a part of the Financial Select Sector SPDR (XLF), had the industry leading efficiency ratio due to its continued focus on core operations.
Size does matter in better operation efficiency
An interesting trend emerges if we break down banks according to their asset sizes. In descending order of asset size, the efficiency ratio decreases up to a certain extent and then rises again. The banks with the best efficiency ratios are those that have between $50 billion and $99 billion in assets. This group performs better on operational efficiency than the big four with more than $1 trillion in assets and the group with $100 billion to $999 billion in assets. This is largely because the banks that fall into this group have a greater focus both in terms of products and the regions in which they operate.