In the credit union and the banking industry, the importance of numbers can't be overstated. Whether it's net new deposits, loan growth, member retention rate, or any other credit union metric, your institution's story can often be told by the numbers. However, few key performance indicators can be as indicative of the financial health and resiliency of your credit union as the efficiency ratio. Let's take a deeper dive into the importance of the efficiency ratio.
How to Calculate Your Efficiency Ratio
The efficiency ratio of your credit union is a measure that helps define what your operational efficiency should be. In short, the efficiency ratio quantifies how well your credit union is utilizing its expenses by gauging the amount you need to spend to earn $1.00 in revenue. Calculating your credit union's efficiency ratio can be relatively straightforward: divide your total operating expenses by total income minus interest expenses.
Total Operating Expenses / Income - Interest Expense =
Your Credit Union's Efficiency Ratio
Benchmarking Your Credit Union's Efficiency Ratio
Within a bubble, your credit union's efficiency ratio may not mean much. However, you can gain insight into the solvency and performance of your credit union compared to the industry when you benchmark your efficiency ratio against the field. In March of 2020, the national average efficiency ratio was 75%. This means that it took the average credit union an estimated $.75 to earn $1.00.
What Does My Efficiency Ratio Mean?
If Your Efficiency Ratio is Low...
Very similar to a company's operating expense ratio, the lower the efficiency ratio, the better. A lower efficiency ratio means your operating expenses are a smaller percentage of the income generated.
In other words, credit unions with a lower efficiency ratio may be more comfortably able to pay operating expenses. These facilities generally demonstrate strong operational discipline in managing expenses. And if your credit union is able to maintain a lower efficiency ratio over longer periods of time, this can increase the ability to:
- Return more capital to credit union members
- Increase and build capital as needed
- Invest in innovative products, solutions, and data infrastructures
If Your Efficiency Ratio is High...
On the flip side, a high efficiency ratio can be a red flag for your credit union, indicating potential underlying issues. It suggests that your credit union may be allocating a larger portion of its income towards overhead expenses, which could be cause for concern.
If your efficiency ratio is on the higher side, it should serve as a prompt for you to take these actions:
- Innovate ways to grow income while keeping the same level of expenses
- Get a better handle on controlling costs
If Your Efficiency Ratio is Fluctuating...
As with any KPI, the efficiency ratio can fluctuate over periods of time. One of the key drivers of these fluctuations is the interest rate. And the changes can be especially significant when a large percentage of the credit union's revenue is generated from loans and other products sensitive to interest rates.
However, if your credit union derives a higher ratio of income from fees, you will—theoretically—see less fluctuation in your efficiency ratio compared to a credit union with less fee income.
Looking to Improve Your Credit Union Efficiency? FLEX Can Help
While often overlooked, the key to lower efficiency ratios and healthier credit unions is your core system. An efficient core data processing system can help you expand member services and attract new members while efficiently managing underlying overhead costs. And FLEX core technology is uniquely engineered to help credit unions do just that. Our innovative system is proven to help amplify operational efficiencies while helping expose and correct inefficiencies.
