ROA, ROE, and the efficiency ratio
| Metric | What it measures | Good for a bank |
|---|---|---|
| Return on assets (ROA) | Profit per dollar of everything the bank owns | Around 1% or more is healthy |
| Return on equity (ROE) | Profit per dollar of the owners' money | Low double digits is healthy |
| Efficiency ratio | Costs as a share of revenue | Lower is better — mid-50s is strong |
How leverage turns 1% ROA into 10% ROE
ROA looks tiny at a bank because the asset base is enormous and funded mostly by deposits, not equity. Leverage is what turns that small ROA into a respectable ROE: carry roughly ten dollars of assets per dollar of equity, and a 1% return on assets becomes roughly a 10% return on equity. The same leverage that lifts ROE also magnifies losses — which is why capital (the next module) matters so much.
Compare ROA, ROE, and efficiency on one bank
On a bank's FDIC Regulatory View panel, compare return on assets and return on equity. The ROE will be roughly ten times the ROA. The efficiency ratio sits nearby — under about 60% is a well-run bank, above 70% is a laggard.
Reading the efficiency ratio between two banks
Bank A has an efficiency ratio of 52%. Bank B's is 71%. Both earn the same revenue. What does the gap tell you?
When high ROE hides heavy leverage
Check your understanding
Sit with the ideas.
A bank reports return on assets of about 1.2% but return on equity of about 13%. What mainly explains the gap between the two?
Why: