The global banking industry is in a fragile state. The economic recovery has been losing steam in many markets, while a wave of regulatory reform is certain to add more costs and create further barriers to creating value.
To gauge how the industry has fared over the past several years, we calculated the economic profit generated by a large sample of banks from Europe, the U.S., and Asia-Pacific. Economic profit (also called value added) provides a comprehensive measure of the financial issues facing banks. It takes a bank’s income and subtracts refinancing and operating costs as well as loan loss provisions (LLPs) and capital charges—two barometers of macroeconomic and regulatory conditions. Together, LLPs and capital charges represent the risk costs incurred by banks.
Risk costs have grown substantially since the start of the financial crisis and, given the regulatory changes on the horizon, will continue to exert pressure on banks. This leads to two imperatives. To better account for these costs, banks should introduce the risk-to-income ratio (RIR) as a key metric. They should also integrate the regulatory and economic perspectives of the new requirements in order to accurately and effectively steer financial resources.