In order to maximize long-term returns, a bank must operate efficiently and balance revenue growth against robust risk management.

1. Keys to Operating
an Exceptional Bank
Efficiency
3

2. There are three interrelated challenges to operating
an exceptional bank:a
(1) revenue growth,
(2) robust risk management, and
(3) efficiency.
(1)
(2)
(3)
Efficiency

3. The first two, revenue growth and risk management,
work against each other, as the fastest way for a bank
to increase revenue is to lower credit standards. This
allows a bank to write more loans, but exposes it to
higher credit risk down the road.
Efficiency

4. Efficiency
Revenue Risk Management
A bank accordingly must balance these two imperatives,
generating enough revenue in the short-run to meet
profitability targets (usually an ROE of 10% or more)
w/out jeopardizing profitability over a longer stretch,
during which the credit cycle is likely to turn down.
=

5. Banks can make this balancing act easier by keeping
operating costs low. This is captured by the efficiency
ratio, which reflects the percentage of a bank’s net
revenue that’s consumed by expenses.
Efficiency

6. Because a bank with a low efficiency ratio presumably
has a higher profit margin than its less efficient peers, it
can afford to compete more aggressively for the most
creditworthy borrowers. As such, efficient banks are
able to reduce credit risk and dial up revenue growth.
Efficiency

7. Thus, if there’s one thing bankers and bank investors
should keep at the forefront of their minds, it’s the
importance of a low efficiency ratio. As the diagram
illustrates, this serves as the foundation upon which
exceptional banks are built.
Efficiency

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