Short answer: A bank's efficiency ratio is non-interest expense divided by net operating revenue (net interest income plus non-interest income). It measures how many cents of overhead the bank spends to generate one dollar of revenue. Lower is better. Most US community banks run between 55% and 70%.
The formula
In plain English:
- Non-interest expense is overhead. Salaries, technology, occupancy, marketing, professional fees.
- Net interest income is interest earned on loans and securities minus interest paid on deposits and borrowings.
- Non-interest income is fees, service charges, mortgage banking gains, securities gains, and so on.
An efficiency ratio of 60% means the bank spends 60 cents of overhead to produce $1 of revenue. The remaining 40 cents covers loan losses, taxes, and net income to shareholders.
What's a good efficiency ratio?
It depends on the bank's size and business model. As a rough guide:
| Range | What it usually means |
|---|---|
| Below 50% | Exceptional. Usually a niche or trust-style bank with very low overhead, or a megabank with deep scale. |
| 50% to 60% | Strong. Common for well-run mid-sized and larger banks. |
| 60% to 70% | Average to good for community banks. |
| 70% to 80% | Cost-pressured. Worth asking why. |
| Above 80% | Yellow flag. The bank is spending most of its revenue on overhead. |
Always check the peer-group percentile rather than the absolute number. A 68% efficiency ratio is poor for a $5B regional bank but normal for a $150M rural community bank with three branches.
Why this ratio matters
Banking is a margin business. A community bank's net interest margin (NIM) might be 3.4%. After you take out loan loss provisions and taxes, the spread between "profitable" and "not profitable" is thin. Overhead is the lever the bank can actually control.
A bank running at a 58% efficiency ratio has structurally more room to absorb a credit-loss spike, a rate-cycle headwind, or a competitive deposit war than a bank running at 78%. Efficiency is the cushion. Two banks with identical asset quality and identical NIM can have wildly different return on equity because one is leaner than the other.
What to watch for
- Trend over level. A bank with a 65% ratio trending up to 70% is in worse shape than a bank steady at 70%.
- Mortgage banking gains. Banks with heavy mortgage banking income see their efficiency ratio swing with origination volume. Strip out the mortgage line if you want a cleaner read.
- Recent acquisitions. An acquirer's efficiency ratio temporarily spikes after a deal closes because of integration costs and the headcount overlap. Wait 4 to 6 quarters before reading it.
- Branch closures. A bank shrinking its branch footprint will often show a step-function improvement in efficiency 2 to 3 quarters after the closures.
Related reading
- What is a UBPR? - the cover page of a UBPR shows the efficiency ratio with its peer percentile.
- What is Net Interest Margin (NIM)? - the other half of a bank's profitability picture.
- How do FFIEC peer groups work? - why peer comparison beats industry averages for this ratio.