What Is Yield on Earning Assets?
The yield on earning assets is a popular financial solvency ratio that compares a financial institution’s interest income to its earning assets. Yield on earning assets indicates how well assets are performing by looking at how much income they bring in.
- Yield on earning assets is a financial solvency ratio that compares an entity's interest income to its earning assets.
- It is a measure of how much income assets are bringing in to the firm.
- A higher yield on earning assets is preferred and indicates that a company is using its assets efficiently.
- A high yield on earning assets also indicates that an entity is able to meet its short-term debt obligations and is not at risk of default or insolvency.
- Banks have to strike a balance between the number of loans offered, the rates charged, and the duration of the loans when compared to assets to achieve the right ratio levels.
- Increasing a low yield on earning assets would require a restructuring of an entity's pricing policy, approach to risk management, and investment strategy.
Understanding Yield on Earning Assets
Solvency ratios shed light on if a financial institution has the ability to stay in business by meeting its short-term obligations. The yield on earning assets is a way for regulators to determine how much money a financial institution is earning on its assets. Large cash yields are preferred, thereby indicating that a company can pay its short-term obligations and is not at risk of default or insolvency.
Banks and financial institutions that provide loans and other investment options that offer yields have to strike a balance between the different types of investment vehicles they offer, the interest rates charged, and the duration of those investments. These factors determine the amount of interest income a debt vehicle will bring in over a specific time frame. This interest income is then compared to the earning assets.
Generally speaking, the higher a company’s loan to asset ratio, the higher its yield on returning assets. This is because the more loans made the more interest income earned or because higher-yielding investment vehicles bring in more income relative to the amount of money loaned out.
High Yield vs. Low Yield
High yield on earning assets is an indicator that a company is bringing in a large amount of income from the loans and investments that it makes. This is often the result of good policies, such as ensuring that loans are appropriately priced, and investments are properly managed, as well as the company’s ability to garner a larger share of the market.
Financial institutions with a low yield on earning assets are at an increased risk of insolvency, which is the reason the yield on earning assets is of interest to regulators. A low ratio means that a company is providing loans that do not perform well since the amount of interest from those loans is approaching the value of the earning assets.
Regulators may take this as an indicator that a company’s policies are creating a scenario in which the company will not be able to cover losses, and could thus become insolvent.
As a measure of effectiveness, yield on earning assets can be useful for comparing different managers relative to their asset bases. Managers, or entire businesses, that can generate sizable yield with a small asset base are considered to be more efficient, and likely offer more value.
Increasing a Low Yield on Earning Assets
Increasing a low yield on earning assets often involves a review and restructuring of a company’s policies and approach to risk management, as well as a review of the general operations of how the company chooses which loans to provide to which markets.
Depending on the business or strategy, at times, yield on earning assets may need to be adjusted for various methods when compiling financial statements. For instance, certain off-balance sheet items could distort reported yield on assets when using financial statements that have not been adjusted to reflect these off-balance sheet items.
Furthermore, financial institutions could be charging low interest rates to remain competitive and gain business, which would result in a lower amount of income earned. In this case, a review of a company's pricing policy would be necessary.