It is difficult to discuss banks’ typical net profit margins, because there is no “typical” bank. In order for comparisons to be meaningful, banks must be grouped with carefully selected peers that are similar on the basis of size, location, growth, profitability and other factors. The banking industry is highly regulated, so information on all banks is reported by the Federal Deposit Insurance Company and the Federal Financial Institution Examination Council, which have tools on their web sites that make comparing net profit margins relatively easy.
Net Interest Margin
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The net interest margin in banking is similar to the gross profit margin for operating companies. It is equal to a bank’s total interest income minus total interest expense. Banks earn interest income primarily from issuing loans to corporations, real estate developers and individuals. Interest expense represents the amount of interest the bank must pay on various interest-bearing deposit accounts that individuals and corporations maintain at the bank. According to the FDIC, the average NIM during fiscal 2012 was 3.42 percent, a decrease from 3.60 percent during the prior year.
See AlsoProfit Margin
Efficiency Ratio
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The efficiency ratio in banking is similar to the operating expenses as a percent of sales reported by operating companies. Banks want efficiency ratios to be low, as the ratio equals non-interest operating expenses as a percent of total income. According to the FDIC, the average efficiency ratio for all FDIC-insured banks was 61.6 percent. For banks with total asset bases lower than $1 billion the average efficiency ratio was 70.3 percent, and for banks with total asset bases larger than $1 billion the average efficiency ratio was 59.4 percent.
Net Profit Margin
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During the first quarter of fiscal 2013, the banking industry recorded record profits totaling $40.3 billion, because of increases in non-interest income such as ATM fees, service charges and income from non-retail banking divisions. Actual interest income declined, but the industry made fewer provisions for future loan losses, implying that the industry feels that the strength of its loan portfolio increased during the quarter. For community and regional banks that are not considered “financial super-markets” like the larger mega-banks, it is typical to report net profit margins approximating 10 percent to 15 percent. Strong performance typically results in a return on equity in excess of 10 percent, and a return on assets in excess of 1 percent.
Quality of Earnings
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Earnings quality is a bank’s ability to continually generate strong earnings performance. As mentioned above, the banking industry reported record profits, however, actual interest income declined. This indicates that the quality of earnings should be analyzed closely, because interest income is the main source of income for banks. An unusually high ROA is often a sign that a bank is engaged in higher risk activities. Also, high quality earnings are typically recurring, and are related to asset quality. If asset quality is low -- which can be checked via the FDIC web site -- and earnings are high, that should be a red flag.
