As of June 2020, the trailing twelve months' net profit margin for retail or commercial banks was approximately 13.9%. This is a sharp decrease from June 2019, when the net profit margin for commercial banks was 27.6%. For comparison, the net profit margin for commercial banks in June 2018 and June 2017 came in at 23.8% and 24.3%, respectively.
The average profit margin for companies in the banking sector can fluctuate greatly depending on financial market conditions. The International Monetary Fund (IMF) attributed the decline in 2020 to the challenges posed by the COVID-19 pandemic. The IMF predicts that globally the banking sector will continue to post declining profits through 2025 due to the ongoing tightening of financial conditions. This could also be attributed to, in part, the rising service and price competition in this sector from the fintech startups taking market share in many segments of banking, namely, lending, payments, insurance, mortgage, and so on.
In this article, we'll compare the profit margins for different types of institutions within the banking sector. Plus, we'll highlight some of the metrics investors and analysts use to evaluate banks as potential investment opportunities.
- As of June 2020, the average net profit margin for retail or commercial banks was 13.9%, a sharp decline over previous years attributed to tightening financial market conditions and the COVID-19 pandemic.
- In the United States, profit margins for regional banks tend to be higher than the profit margins for money center banks.
- To correctly analyze banks, it's important to compare companies that operate similarly, serve the same marketplace, and are similar in size.
- Three key metrics for investors to use when evaluating companies in the banking sector as potential investments are net interest margin, efficiency ratios, and the return on assets (ROA) ratio.
Comparisons of Bank Profit Margins
It is somewhat difficult to even talk about an average profit margin for the banking industry. Profit margins between different banks can vary from as low as 5% up to as high as nearly 45%. The profit margin for regional banks tends to be higher than that of money center banks, 25.7% on average as of June 2020. Money center banks operate with lower profit margins, averaging a trailing twelve months' net margin of around 20%.
But since money center banks deal in very large capital amounts, a 20% net profit for a given money center bank may represent an absolute dollar amount substantially higher than the amount represented by a 25.7% profit margin realized by a regional bank.
A proper analysis would only compare banks similar in the major business they conduct, their sizes, and the specific marketplaces they serve. It isn't valid to compare a regional retail bank to a large investment bank, nor is it valid to compare an investment bank in India to an investment bank in the United States.
Metrics for Assessing Banks
Investors and analysts can use equity valuation metrics to assess banks. Three commonly used metrics are net interest margin, efficiency ratios, and return on assets.
Net Interest Margin
The net interest margin is, for banks, a similar measure to gross profit margin for most companies, calculated by subtracting total interest expense from the bank's total interest income. Interest income for banks comes primarily from issuing loans. Interest expenses represent the interest that banks must pay on the variety of deposit accounts held by the bank's customers.
As of the first quarter of 2022, the average net interest margin for U.S. commercial banks was 2.10%. The net interest margin can vary depending on the type and size of the bank. For example, between 2011 and 2021, the net interest margin for bank holding companies with assets greater than $750 billion consistently trended lower than the net interest margin for bank holding companies with assets between $50 billion and $750 billion.
Efficiency ratios are another commonly used metric for evaluating banking firms. Efficiency ratios measure how well a company utilizes its resources to make a profit. These ratios also help companies measure their performance against pre-determined goals and against their competitors in the same industry.
The goal for banks is to keep efficiency ratios low because they represent non-interest operating expenses as a percentage of the bank's total income. Efficiency ratios for the banking industry typically fall between 60% and 70%.
Return on Assets Ratio
The return on assets (ROA) ratio is important to companies in the banking sector because it determines how profitable the company is relative to its total assets. A bank's ROA ratio is calculated by dividing the net, after-tax income by its total assets. Because banks are highly leveraged, even a seemingly low 1% or 2% ROA can still represent large revenues and profits. For the first quarter of 2022, U.S. commercial banks had a ROA of 0.93%.