The average debt-to-equity (D/E) ratio for retail and commercial U.S. banks, as of January 2015, is approximately 2.2. For investment banks, the average DE is higher, about 3.1.
The debt-to-equity (D/E) ratio is a leverage ratio that shows how much a company's financing comes from debt or equity. A higher D/E ratio means that more of a company's financing is from debt versus issuing shares of equity.
A relatively high D/E ratio commonly indicates an aggressive growth strategy by a company. For investors, this means potentially increased profits with a correspondingly increased risk of loss. If the extra debt that the company takes on enables it to increase net profits by an amount greater than the interest cost of the additional debt, then the company should deliver a higher return on equity to investors.
However, if the interest cost of the extra debt does not lead to a significant increase in revenues, the additional debt burden would reduce the company's profitability. In a worst-case scenario, it could overwhelm the company financially, resulting in insolvency and eventual bankruptcy.
Typically, a D/E ratio of 1.5 or lower is considered good, and ratios higher than 2 are considered less favorable, but average D/E ratios vary significantly between industries. Therefore, when examining a company's D/E ratio, investors should compare it with the ratios of similar companies in the same industry.
A relatively high D/E ratio is commonplace in the banking industry and the financial services sector as a whole. Banks carry higher debt amounts because of the amount of fixed assets that banks own as a result of their branch network.