Federal Reserve District, 8th ; Bank profits ; Banks and banking - Costs

R. Alton Gilbert

English

Research Papers in Economics

NET INCOME of member banks in the Eighth
Federal Reserve District increased 3.5 percent in 1972
to $153 million, compared to a 7.1 percent increase in
1971. The rate of return on equity capital was 11.2
percent, down slightly from 11.4 percent in the pre-
vious year. Operating expenses increased at a faster
rate than operating income in 1972, but a decline in
income taxes resulted in the small rise in net income.
The profitability of banks depends upon a number
of factors including existing business conditions, bank
size, efficiency of operations, leverage (volume of
deposits to equity capital), and the extent of com-
petition among banks. Overall bank profitability and
some determinants of profitability can be measured by
using a number of operating ratios as rate of return on
capital, rate of return on assets, ratio of capital to
assets, rate of return on loans, and labor costs to op-
erating income.
These ratios vary among banks of different size
groups and among banks in different types of market
areas. This article discusses these variations among
member banks in the Eighth Federal Reserve District
and points out some possible causal factors for the
differences.
INCOME MD EXPENSES
Total operating income of member banks in the
Eighth Federal Reserve District increased 10 percent
in 1972, compared to a 7.6 percent increase in the
previous year (Table I). Operating income of banks
consists primarily of earnings on loans and invest-
ments, income from trust departments, and service
charges on deposit accounts. Income from loans rose
10.6 percent, significantly higher than the 2.2 percent
increase in the previous year. This change reflects
primarily the growth in the volume of loans since the
average rate of return on loans was 8.1 percent in
both years.
Page 16
Meanwhile, total operating expenses increased 12.9
percent in 1972, as compared to an 11.3 percent in-
crease in the previous year. Interest paid on deposits,
which accounted for 42 percent of operating expense
in 1972, increased 14.2 percent. The rise in interest
on deposits reflects primarily a larger volume of time
and savings deposits, as the average rate paid re-
mained unchanged at 4.8 percent.
Income before income taxes and security gains or
losses declined 1.2 percent. However, income taxes
declined by more than operating income, producing a
3.5 percent rise in net income. The decline in income
taxes reflected in part a larger portion of operating
income derived from nontaxable securities, and in
part a change in tax accounting procedures. Income
from nontaxable state and local government securities
was 9 percent of operating income in 1972, compared
to 8.5 percent in the previous year. Net income ad-
justed for inflation (real net income) rose by only
0.5 percent, compared to a 2.4 percent increase in
1971.1
OPERATING RATIOS
?vlany of the bank operating ratios supply interest-
ing information about bank profitability. Some of these
ratios for member banks in the Eighth Federal Re-
serve District vary according to bank size and location.
These variations are shown in Table II which gives
selected operating ratios by size groups and by loca-
tion inside or outside metropolitan areas for the years
1970-72.
Rate of Return on Equity Capital
The rate of return on equity capital tended to be
higher for banks located outside metropolitan areas
than for banks of the same size inside metropolitan
1
Calculated by deflating net income by the implicit price
deflator for gross national product.
Income and Expenses of Eighth District
Member Banks
by R. ALTON GILBERTC
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oTable II
SELECTED OPERATING RATIOS OF MEMBER BANKS FOR THE YEARS 1970, 1971, AND 1972 0
— Ph
EIGHTH FEDERAL RESERVE DISTRICT
(Operating ratios in percentages)
_____ ____ Banks by Deposit Size________
Group 1 Group 2 Group 3 Group 4 Group 5 Group 6
up $5,000,000 $30,000,000 $25,000,000 $50,000,000 $100,000,000
to to to to to and
$5,000,000 $10,000,000 $25,000,000 $50,000,000 $100,000,000_______ over Ph
Non Non Non Non Non Non
Metro- Metro- Metro- Metro- Metro- Metro- Metro- Metro- Metro- Metro- Metro- Metro- z
Operating Ratto polttan politon poluton politan pottton poltton poltton potitan potitan potitan politan politan ~
(I) Net Income to Equity Capital Including
all Reserves
1970 9.70 8.40 32.34 10.81 12.1) 9.14 12.14 11.08 11.41 9.46
1971 9.25 9.80 12.00 10.46 12.3] 10.68 12.10 11.59 10.50 10.13 r
¶972 8.25 8.34 11.36 9.18 12.33 11.06 12.26 11.45 10.61 9.66
Average 9.07 8.85 11.90 10.35 12.25 10.29 12.17 11.37 10.84 9.75
(2) Net Income to Total Assets
3970 1.03 0.79 1.06 0.88 1.00 0.80 3.03 1.06 0.89 0.84
1971 0.95 0.91 1.05 0.82 0.97 0.90 0.99 1.03 0.84 0.83
1972 0.79 0.70 0.96 0.79 0.94 0.91 1.03 0.87 0.84 0.75
Average 0.92 0.80 1.02 0.83 0.97 0.87 1.02 0.99 0.86 0.81
(3) Interest and Fees on Loans to Loans
1970 7.92 8.24 7.99 8.46 8.14 7.70 8.25 8.08 8.04 8.34
1971 8.09 8.26 8.14 8.17 8.18 8.01 8.13 785 7.74 7.67
1972 8.18 8.25 8.20 8.48 8.13 8.25 8.04 7.88 7.59 7.62
Average 8.06 8.25 8.11 8.37 8.15 7.99 8.14 7.94 7.79 7.88
(4) Net Loss (—) or Recoveries on Loans to
Total Loans
1970 —0.34 —0.62 —0.29 —0.29 —-0.25 —0~28 —0.29 —0.15 —0.30 —0.54
1971 —0.18 —0.21 —0.37 —0.11 —0.20 —0.19 —0.28 —0.26 —0.14 —0.22
1972 —0.17 —0.17 —0.13 —0.06 —0.13 —0.17 —0.35 —0.11 —0.16 —0.12
Average —0.23 —0.33 —0.20 —0.15 -0.19 —0.21 0.24 —0.17 —0.20 —029
(5) Interest and Fees on Loans to Total
Operating Income
1970 56.77 55.37 59.47 60.27 62.66 62.79 65.53 62.37 68.19 71.12
1971 56.47 55.77 58.18 57.90 60.84 62.72 65.04 59.73 63.61 6686
1972 55.94 55.48 59.19 63.44 61.26 60.09 62.67 63.84 62.13 67.31
Average 56.39 55.54 58.95 60.54 61.59 61.87 64.41 63.98 64.64 68.43
(6) Income from Sources other than Loans and C
Investments to Total Operating Income C,
1970 6.85 8.52 6.74 10.84 8.52 10.39 10.61 13.28 10.52 14.53 C
1971 6.69 8.50 6.44 9.14 7.98 11.37 9.89 14.65 12.15 16.5)
1972 6.50 7.35 6.02 10.02 7.86 11.37 ¶1.92 9.27 10.28 15.36
Average 6.68 8.12 6.40 10.00 8.12 11.04 10.81 12.40 10.98 35.47- - Banks by Deposit Size
Group 1 Group 2 Group 3 Group 4 Group 5 Group 6
up $5,000,000 $10,000,000 $25,000,000 $50,000,000 $100,000,000
to to to to to and
$5,000,000 $10,000,000 $25,000,000 $50,000,000 $100,000,000 over r
Non Non Non Non Non Non
Metro- Metro- Metro- Metro- Metro- Metro- Metro- Metro- Metro- Metro- Metro- Metro-
Operating Ratio palitan potitan politan politan politan politan politan potiton politon potiton politon politon P1
(7) Trust Department Income to Total Operating ‘ti
Income
1970 0.03 000 0.18 0.06 0.41 0.81 127 4.09 1.14 3.50
1971 0.13 0.41 0.18 0.05 0.4! 0.53 095 4.56 1.49 3.56
1972 0.1! 0.71 0.13 0.53 0.29 0.45 2.38 0.72 1.37 332 C
Average - 0.09 0.37 0.16 0.21 0.37 0.60 1.50 3.12 1.35 3.46
(8) Salaries, Wages, and Officer and Employee
Beneflts to Total Operating Income S
1970 23.56 23.77 21.86 21.46 20.21 22.93 21.66 23.62 20.24 22-00
1971 23.31 23.68 21.28 22.44 19.68 22.79 20.37 22.97 21.35 22.25
¶972 23.59 26.75 20.95 2100 19.11 21.96 19.62 21.01 20.13 22.34
Average 23.49 24.73 21.36 21.63 19.67 22.56 20.55 22.53 20.57 22.20
(9) Total Capitot Accounts and Reserves to
lotal Assets
1970 ¶0.61 9.26 L87 9.30 8.47 8.50 8.59 9,87 8.44 9.42
1971 1030 10.72 9.04 8.44 t08 8.92 8.46 9.33 8.53 8.84
1972 10.22 8.00 8.78 8.92 7.86 8.81 8.68 8.11 8.41 8.44
Average 10.38 9.33 8.90 8.89 8.14 8.74 8.58 9.10 8.46 8.90
(10) Capitol Notes and Debentures to Total
Capital
1970 0.15 0.00 0.34 1.14 0.76 0.29 0.00 2.23 5.18 4.44
1971 0.00 0.00 0.37 1.36 0.55 0.20 1_So 2.21 4.95 4.60
1972 0.00 0.00 0.13 0.00 0.97 1.75 1.44 2.46 4.94 4.66
Average 0,05 0.00 0.28 0.83 0.76 0.75 0.98 2.30 5.02 4.57
(11) Interest on Capital Notes and Debentures
to Total Operating Income
1970 0.01 0MG 0.02 0.10 0,06 0.02 0.00 0.17 0.39 0.36
1971 0.00 0.00 0.02 0.13 0.03 0.01 0.19 0.15 0.47 0.40
1972 0.00 0.00 0.01 0.00 0.06 0.12 0.12 0.15 0.44 0.42
Average 0.00 0.00 0.02 0.08 0.05 0.05 0.10 0.16 0.43 0.39
Number of Banks
1970 83 8 114 ¶4 129 27 30 17 16 18
1971 58 8 98 11 138 30 30 14 20 20 C,
1972 48 4 82 15 148 28 38 15 17 24
-l 5
The selected operating ratios are presented for each group in which there was an average of five or more banks during the years 1970.72.
NOTE: The boundaries of the Tenth Federal Reserve District were expanded on January 24. 1972 to include several counties in Western Missouri which had been in the Eighth Federal
Reserve District. The operating ratios for 1970 and 1971 have been adjusted to conform to the January 24. 1972 revision in district boundaries. 03FEDERAL RESERVE BANK OF ST. LOUIS
lion was 9.75 percent. The higher rate of return on
capital among banks with $10 million to $50 million
in deposits may reflect the higher efficiencies of banks
in this category; the lower rate of return to banks with
over $50 million in deposits may reflect the influence
of greater competition offsetting to some extent the
economies of scale. The very large banks compete
throughout the nation for the larger corporate
accounts.
Net Income as a Percentage of Total Assets
Bank size and location also had an impact on net
income as a percentage of total assets (see Ratio 2).
Banks in nonmetropolitan areas had higher returns on
total assets than similar sized banks in metropolitan
areas. Moderately sized banks (deposits of $5 million
to $50 million) had the highest returns on total assets
for both metropolitan area and nonmetropolitan area
banks. These returns are probably influenced by both
efficiencies of scale and competition, and indicate that
the pattern of rates of return on capital to banks of
different sizes and location is not completely deter-
mined by variations in leverage. The higher returns
on assets at medium-size banks may reflect rising re-
turns to scale. The degree of competition in their
respective markets, however, may be the chief causal
factor in the higher returns to banks in nonmetropoli-
tan areas and the lower returns at large banks which
operate in the more competitive metropolitan area
markets.
Rate of Interest on Loans
One of the detenninants of the profitability of banks
is their rate of interest of loans. According to Ratio 3,
the average interest rate was about 8 percent during
the period 1970-72. Interest rates at banks with de-
posits up to $10 million were above average and rates
at banks in metropolitan areas with deposits greater
than $10 million were below average. Interest rates
were lowest for banks with deposits over $50 million,
There were no systematic differences between rates
on loans for banks of the same size in metropolitan
and nonmetropolitan areas.
These differences in interest rates on loans do not
necessarily indicate that customers were charged
higher interest rates for the same types of loans at
small banks. Since the rate of interest on loans for
each bank equals its total interest and fees as a per-
centage of total loans shown on the Reports of Con-
dition, the type or size of loans made is not held
constant in calculating the average rates.
Page 20
AUGUST 1973
The average net loss or recovery on loans as a per-
centage of total loans shows no obvious pattern ac-
cording to bank size or location (see Ratio 4). There-
fore, the average rate of interest on loans has the same
pattern with average loan losses subtracted. One con-
sistent pattern is that loan losses tended to be greatest
during 1970, a year of recession, and lowest during
1972, the second year of the recent recovery.
Interest and Fees on Loans to Total
Operating Income
Fees
Percent
10
S
0
Another determinant of the profitability of banks is
the proportion of operating income derived from loans
Operating Ratios — Interest and
on Loans to Total Loans
Percent
15
S
0
Gooopt Ooop2 G,os+p3 Gooop4 O,oop5 O,00pó
op to $5,000,000 $tO,000,000 $25,000,000 $50,000,000 $100,000,000
$5,000,000 0t O to to ood
$]0,000,000 $2&000,000 $50,000,000 $100,000,000
to,],, by Deposit Sin
‘Aseooges of Eighth Di,toiot “obey books to, 1970,1971, ood 972
Operating Ratios — Interest and Fees
on Loans to Total Operating Income
— G’oog] Otoop2 ]StsopJ 0,0+94 Otoops O,oop
op to $5,050,000 $10,000,000 $25,000,000 $50,000,000 Sl0’O,000,000
55,002.000 to to to to
$10,000,000 $25,000,000 $50,000,050 0]00,000,000
Books by Doposit 5,00
‘As’oogoo of Eighth D’,ot,i of ,oo,oboy books to, 1970. 97]. cod 1977FEDERAL RESERVE SANK OF ST. LOUIS AUGUST 1973
(interest rates are generally higher on loans than on
securities). Ratio 5 suggests that the percentage of
operating income from loans was positively related to
bank size. The smallest banks (deposits up to $5
million) received about 55-56 percent of their operat-
ing income from loans, and the largest banks (deposits
of $100 million and over) received an average of 68
percent of their operating income from loans.
Percentage of Income from Sources other
than Loans and Investments
One measure of the extent to which banks offer
varied services is the percentage of operating income
derived from sources other than loans and invest-
ments (Ratio 6). This measure appears to be related
to both bank size and location. In general, the larger
banks and banks in metropolitan areas received a
greater percentage of income from sources other than
loans and investments.
One of the more important sources of such income
is that derived from trnst departments. The percent-
age of operating income from trust departments is
positively related to bank size and is larger for banks
in metropolitan areas than for nonmetropolitan area
banks in the same size group (see Ratio 7). These
results are consistent with the propositions that the
demand for trust services at banks of equal size
tends to be greater in metropolitan areas and that
larger banks benefit from offering specialized trust
services.
Labor Costs
Variations in the ratio of labor costs to operating
income were not greatly different among banks of
different sizes and locations (see Ratio 8). This ratio
tended to be slightly higher for banks in metropolitan
areas, possibly reflecting the influence of higher wage
rates. The ratio was also higher for banks in the
smallest size category (deposits up to $5 million),
possibly reflecting the lack of automation.
Total Capital to Total Assets
The profitability of banks is partially determined by
their leverage, measured in Ratio 9 as the ratio of
total capital to assets. The lower this ratio, other things
held constant, the higher the rate of return on capital.
Banks in the smallest size group had the highest and
banks with deposits between $10 million and $25
million had the lowest average ratio of capital to
assets. Since the relation between capital and assets is
to some extent dictated by bank regulatory agencies,
it is difficult to determine what economic forces these
ratios reflect.
Capital Notes and Debentures
In recent years banks have been adding to their
capital accounts by issuing capital notes that are
subordinated to deposit liabilities. Such notes give
depositors more protection and the banks more lever-
age for equity capital. Ratio 10 shows capital notes as
a percentage of total capital accounts. There is some
indication that banks in metropolitan areas have is-
sued more capital notes than nonmetropolitan area
banks. Also, larger banks have tended to issue more
capital notes than smaller banks. Ratio 11 shows inter-
est on capital notes as a percentage of total operating
Operating Ratios — Trust Department Income
to Total Operating lncome
000972 Oooop
3 0
00op4
tsp to $5,000,000 $tO,000.000 $25,000,000
$5,~,000 00 tO to
$t0,000,000 $25,000,000 $50,~.000
Bosh, by DepotS Size
°Aoooogeo
0
t Eighth D’,styiot membet both, foe 970 1971,
0~
°~t’~ Otooph
$50,000,000 $100,000,000
to o,dooee
$100
otd t972
Operating Ratios — Total Capital Accounts
and Reserves to Total Assets
2 otoopi o,noop 4t~ooopoo,eoop’’
op to $5,000,000 $tD,000,000 $25,000,000 $50,000,000 $100,000,000
$5,~,000 to to to to ood 00,t
$10,000,000 $25,000,000 $50,000,000 $100,000,000
Book, by Deposit Sb,
‘Avetoges of Eighth D’otoiot comb,. book, for 970. 97]. oS 1972
Page 21FEDERAL RESERVE BANK OF ST. LOUIS AUGUST 1973
income. This ratio has much the same pattern among
the banks by size groups and location as the ratio of
such notes to total capital.
SUMMARY
Income before income taxes and securities gains or
losses for member banks in the Eighth Federal Re-
serve District declined in 1972. Total operating income
increased 10 percent, but total operating expenses
increased faster. Interest on deposits increased at even
more rapid rates, reflecting the growth of time and
savings deposits. A reduction in income taxes due to
a shift of bank assets into nontaxable securities and
changes in tax accounting procedures accounted pri-
marily for a 3.5 percent rise in net income.
A number of operating ratios of Eighth District
member banks for 1970-72 are shown to vary accord-
ing to bank size and location. Average rates of return
on equity capital were higher for banks of the same
size in nonmetropolitan areas than for those in met-
ropolitan areas. Banks with deposits between $10
million and $50 million had higher rates of return
than banks in other size categories. Banks with de-
posits over $50 million had a lower average rate of
return on loans than those in smaller size categories.
The percentage of total operating income from loans
was positively related to bank size.
The rate of return on capital is influenced by the
amount of capital banks have in relation to their as-
sets. The higher the ratio of capital to assets, other
Operating Ratios — Capital Notes
and Debentures to Total Capital Account?
00097] btoopl t.,roopi t.otoop
4
Groups Group
op to $5,000,000 $10,000,000 $25,000,000 $50,000,000 $100,000,000
$5000000 ~0 to to to oodooet
$10,000,000 $25,000,000 $50,000,000 $]00,000,000
Boths by Dopotit Size
°Aotoogeoof Eighth Diottiot toombot books tot 1970, 197], oS 1972
things equal, the lower the rate of return on capital.
Banks of moderate size, with deposits between $10
million and $25 million, had the lowest average ratio
of capital to total assets, which partially explains why
moderately sized banks had the highest average rate
of return on capital.
Page 22

Income and expenses of Eighth District member banks

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Income and expenses of Eighth District member banks

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