efficiency ratio

Efficiency Ratio

In banking, a ratio of expenses to revenue. For example, if a bank spends $10 million and makes $15 million in a given month, its efficiency ratio is .67. Banks desire a lower efficiency ratio because this means that the bank is making considerably more than it is spending and is therefore on sound fiscal footing. One way to conceptualize the efficiency ratio is to say it is the measure of what a bank must spend in order to make one dollar. In the above example, the bank must spend 67 cents.

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efficiency ratio

The ratio of leasable space to gross space in a building.When planning a building, it is important to balance the need to maximize the efficiency ratio in order to lease the maximum amount of space possible,against the aesthetic need to have wide corridors and open spaces.

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Efficiency Ratio

What Does Efficiency Ratio Mean?

A ratio used to calculate a bank's efficiency. Not all banks calculate the efficiency ratio the same way. The ratio can be calculated one of four ways: (1) noninterest expense divided by total revenue less interest expense, (2) noninterest expense divided by net interest income before provision for loan losses, (3) noninterest expense divided by revenue, (4) operating expenses divided by fee income plus tax equivalent net interest income. In all four methods, an increase means the company is losing a larger percentage of its income to expenses. If the efficiency ratio is getting lower, it is good for the bank and its shareholders. Also referred to as the overhead burden or overhead efficiency ratio.

Investopedia explains Efficiency Ratio

Regardless of which ratio calculation method is used, the efficiency ratio's purpose is to evaluate the overhead structure of a financial institution. Banking is no different from any mature industry: Companies that survive keep their costs down. The efficiency ratio measures how effectively a bank is operating and how profitable it is.

Related Terms:
• Cash and Cash Equivalents
• Expense Ratio
• Net Income—NI
• Net Operating Income—NOI
• Operating Expense