im03 - Chapter 5 Managing Noninterest Income and...

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Chapter 5 Managing Noninterest Income and Non-interest Expense Chapter Objectives 1. Introduce financial ratios that characterize a bank’s ability to generate noninterest income and control noninterest expense. 2. Document the sources of bank noninterest income. 3. Explain the significance of the efficiency ratio and operating risk ratio. 4. Explain the importance of knowing which customers are profitable. 5. Describe the link between business mix and fee income. 6. Describe various strategies to manage noninterest expense. Key Concepts 1. Because banks face strong competition in pricing loans and deposits, their net interest income and NIMs are likely to remain stable or decline over time. To grow earnings, banks must increasingly rely on noninterest income and expense controls. 2. The bulk of bank noninterest income comes from deposit service charges and fees from services such as trust management, securitization, mortgage banking, asset management, and investment banking and trading for the largest banks. 3. Bankers and analysts typically measure performance over time and versus peer banks via their burden, noninterest expense minus noninterest income, the net overhead expense equal to the burden as a fraction of total assets, and the efficiency ratio, equal to noninterest expense divided by the sum of net interest income and noninterest income. In each case, better performance is indicated by a smaller figure or percentage. 4. Productivity ratios help indicate how efficiently banks are using their employees relative to capital assets. Two commonly cited ratios are assets per employee and average personnel expense. The more productive bank typically has fewer employees per dollar of assets held and often controls personnel expense per employee better. Still, this latter ratio is often high for high performance banks because they operate with fewer people but pay them more. 5. Typical analyses of customer profitability profiles suggest that banks make most of their profit from a relatively small fraction of customers. The traditional view is that up to 80 percent of a bank’s customers are unprofitable when all services are fully costed. Such figures support the increase in fees assessed by most banks over the past few years. 6. Banks pursue a variety of cost management strategies to control non-interest expense. Four different strategies are: 1) expense reduction, 2) increase operating efficiency, 3) changing product pricing, and 4) pursuing contribution growth whereby non-interest revenues rise by more than non-interest expense. Teaching Suggestions One of the most significant trends in bank performance over the past 10 years is the increasing reliance on noninterest income versus net interest income. It is important to motivate the discussion of noninterest
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income and noninterest expense by documenting the flat or declining net interest margins at most banks during the latter 1990s and early 2000s, and emphasizing the fact that banks’ future earnings growth will
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im03 - Chapter 5 Managing Noninterest Income and...

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