Cost-income ratio

Cost-income ratio
See also

Cost income ratio (CIR) is emerging measure of bank`s efficiency and a benchmarking metric. As a standard indicator of the bank's efficiency, CIR measures the operating costs of the bank in relation of its total income. CIR also affects bank`s profitability[1].

The efficiency in banks is mainly based on the cost income ratio (CIR), which is also known as efficiency ratio. Despite this prediction CIR power is not clear at all, this ratio is widely regarded as a measure when comparing productivity and efficiency of banks. However that high CIR is equivalent low producitvity and low efficiency, and vice versa. Consequently, then a revised CIR is suggested. The procedure allows orientation and pragmatic, which is performance measurement in banks[2].

Cost income ratio algebraic formulation[3]\[= 1 - { \frac{ROE}{(1- TaxRate) } \cdot X Equity/Income} - BadDebtExpense/Income \]

The cost income ratio structure[edit]

The cost income ratio puts administrative costs (expenses) and operating income (earnings) of the bank relation to each other. The cost income ration shows how many dollars (or euros etc.) were needed in a given period of time to generate one dollar (or euro etc.) in revenue. Namely,the CIR measures the output of abank in relation to the contribution used. Figure 1 shows ingredients needed to determine CIR[4].

Factors that affect the cost income ratio[edit]

Additional factors influence the CIR further reduction of the predictive power efficiency. These factors are not connected to and therefore irrespective of the level of service production. However, they have a direct impact on earnings and expenses of the bank, and consequently effect the CIR[5]:

  • Business model: a specific business model a the bank has a direct influence on CIR.
  • Regional focus: As shown above in the example concern margins, commission fees and factor costs vary greatly in individual countries as well.
  • Cyclical improvements of income: it seems that CIR be more favorable in times of boom due excessively high earnings. Characteristic times by the deterioration of the economic situation generate a decrease in earnings, which results less favorable CIR.
  • Non-recurring effect: Non-recurring income, such as the sale of shares or non-recurring costs caused by restructuring programs, is allowed the CIR calculation. Banks rarely reveal corrected CIR values.
  • Risk affinity: bank's risk affinity with regard to granting loans has a significant impact on CIR. Higher affinity for risk leads to higher interest margins causeto higher risk premiums. In this way, interest salary increase and profits CIR decreases. Deferred risk adjustments are not included in the CIR calculations.
  • Balance sheet management: The balance sheet the bank's policy influence the refinancing costs along the yield curve. These costs are taken into account in interest income and thus have impact on CIR.

Footnotes[edit]

  1. Capital Adequacy, Cost Income Ratio and the Performance of Commercial Banks: The Kenyan Scenario 2009
  2. Capital Adequacy, Cost Income Ratio and the Performance of Saudi Banks 2013
  3. Cost to income ratio in Australian banking 1998
  4. Productivity in banks: myths & truths of the cost income ratio 2009
  5. Productivity in banks: myths & truths of the cost income ratio 2009

References[edit]

Author: Wojciech Ślusarczyk