Efficiency Ratio

Efficiency Ratio

A ratio used to calculate a bank's efficiency. Not all banks calculate the efficiency ratio the same way. We've seen the ratio calculated as all of the following:

1. Non-interest expense divided by total revenue less interest expense

2. Non-interest expense divided by net interest income before provision for loan losses

3. Non-interest expense divided into revenue

4. Operating expenses divided by fee income plus tax equivalent net interest income.

For all versions of the ratio, an increase means the company is losing a larger percentage of its income to expenses. If it is getting lower, it is good for the bank and its shareholders.

Notes:

However the ratio is calculated, its purpose is to evaluate the overhead structure of a financial institution. Banking is no different from any mature industry - the surviving companies are those that keep costs down. The efficiency ratio gives us a measure of how effectively a bank is operating. Efficiency is usually a decent measure of profitability.

Also referred to as the "overhead burden" or "overhead efficiency ratio".

See also: Expense, Net Income, Net Operating Income, Operating Expense, Overhead