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. Non-interest expense divided by total revenue less interest expense

2. Non-interest expense divided by net interest income before provision for loan losses

3. Non-interest expense divided by revenue

4. Operating expenses divided by fee income plus tax equivalent net interest income.

For all versions of the ratio, 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
However the ratio is calculated, its purpose is to evaluate the overhead structure of a financial institution. Banking is no different from any mature industry - the surviving companies are those that keep costs down. The efficiency ratio gives us a measure of how effectively a bank is operating. Efficiency is also a good measure of profitability.