The efficiency ratio has emerged as a key measure of how well banks manage their expenses, an important consideration in these competitive times. But ask executives at banks where noninterest expense per dollar of revenue is higher than at peer institutions, and you're likely to get a somewhat prickly response.
The efficiency ratio has two sides, they say - expenses and revenue. And it can present a distorted picture of a bank's efficiency, depending on the lines of business.
Analysts agree that the ratio is a far from perfect measure. "It is somewhat crude," said Sally Pope Davis, an analyst with Goldman, Sachs & Co. in New York.
"The danger of the efficiency ratio is that it has a numerator and a denominator that can go in different directions," she said. "You can take your efficiency ratio down through expenses or through revenue growth. So you have to look at what's really going on beneath that ratio."
Banks with major processing operations, for example typically post higher numbers. "So you're going to have a State Street (Boston Corp.), which obviously has the big processing businesses, running at about a 74% overhead ratio," said Ms. Davis.
"We obviously have to look at that picture," said Thomas H. Hanley at CS First Boston in New York. "But we look at the other ratio, of noninterest expense to average earning assets . . . if you don't want it distorted by a bank that has a weak revenue picture and you really want to get a feel for noninterest expenses."
But what analysts would prefer is more information about lines of business. "You can look at the the whole entity, the way these companies have been analyzed for many years," said Mr. Hanley, "or you can start to break down the actual strategies, technologies, whatever, noninterest expense ratios - by business line. That's where we're going. And that's where the analytical community should be going."
"This is an industry that has been, by and large, very poor on segment reporting," said Ms. Davis. "If you have segment reporting, then you can compare your processing business to that of State Street, to that of Mellon, to that of Bank of New York."
Meanwhile, she added, "we have to kind of make do with what we've got.
