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Measuring Your Bank's Operating Efficiencies

With increased competition from outside the industry, banks continue to experience interest margin pressures. Individual banking companies and the banking industry as a whole are striving to find greater efficiencies in their day-to-day operations. In large banking companies, some of these efficiencies are sought by merging entities and therefore in the process, eliminating redundancies in all aspects of operations. For smaller institutions, efficiency gains are usually achieved by controlling costs and generating more diverse and higher levels of non-interest revenues.

When evaluating a bankís operating efficiency, a series of measures that incorporate an analysis of the bankís level of non-interest expense relative to the bankís non-interest income, earning asset level and overall revenue base are necessary.

The first of these measures, the Operating Efficiency Ratio, is created by dividing non-interest expense by net bank revenue on a tax equalized basis.

Net bank revenue is defined as the sum of tax equivalent interest income plus non-interest income less interest expense. This efficiency ratio demonstrates the institutionís ability to support its net revenue stream with as little overhead expense as possible. In todayís operating environment, targeted efficiency ratios between 50-55% are considered to be acceptable. The second measure, Net Overhead to Earning Assets, is computed by subtracting non-interest income from gross non-interest operating expense, excluding the provision of loan losses. This net overhead "burden" , expressed as a percentage of earning assets provides for a comparison with the net interest margin percentage. The expression of efficiency is useful for demonstrating the net expense level of the bank relative to itís earning asset base. For most banking companies today, (with the exception of some large banks whose net overhead % is below 1.00%) net overhead to earning asset ratios that are maintained below 2.00% are considered to be exceptional.

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