SACRAMENTO, Calif. – The California Department of Financial Institutions on Thursday announced it is now implementing an “efficiency ratio” to better identify and communicate the earnings performance of credit unions.
The efficiency ratio is composed of overhead costs (not including the provision for loan loss expense) divided by operating income, and provides (in cents) how much it costs to produce each dollar of revenue.
A credit union with an efficiency ratio of 60%, for example, spends 60 cents to earn each $1 of revenue. As a general rule, the lower a credit union’s efficiency ratio, the better its performance, according to the DFI.
Credit unions will not be required to use this ratio and examiners will not always include the efficiency ratio in their reports.
“As credit union margins shrink and the industry becomes more competitive, credit unions are faced with a growing challenge to assess the quantity and quality of earnings,” said the DFI. “Despite the current fact that the efficiency ratio is not considered a ‘key ratio’ by the NCUA in the review of a credit union’s earnings, the efficiency ratio has been a commonly used measure of efficiency in the financial industry for quite some time.”
“Examiners often comment on the ‘efficiency’ of a credit union’s operations in the Examination Overview and in other sections of the report of examination, yet find it difficult to effectively quantify and communicate the assessed level of those efficiencies to the credit union,” the DFI said. “Using the efficiency ratio will give examiners another tool to better identify and communicate the earnings performance of credit unions.”
