CU Employee CULytics Founder

How efficient is your credit union?

At the recent 2018 Credit Union Analysis Summit, Jon Voorhees from Peak Performance Consulting talked about Efficiency Ratio and how Credit Unions should use it to analyze their overall performance and more specifically branch performance. 

At the core, all credit unions are similar. They borrow money (as savings, checking, certificate deposits, etc.) at one interest rate from members and then lend it out at a higher interest rate (as credit card loans, auto loans, mortgages, etc.) and pocket the spread between the two as their main source of income.

Definition of Efficiency Ratio

Efficiency ratio is essentially how efficiently credit unions are operating to generate the income. The formula for efficiency ratio is very simple.

Efficiency Ratio = Non-Interest Expense / (Net Interest Income + Net Non-Interest Income)

Net Interest income is the difference between the revenue generated by a credit union and the expenses associated with paying out the liabilities. Typical credit union’s assets include assets such as credit card balances, auto loans, personal loans, and mortgages. And the liabilities include all the deposits. The difference between the interest revenue generated from assets, minus the interest paid out on the deposits, is the net interest income.

Non-interest income is the income that credit unions generate primarily from fees such as insufficient funds (NSF) fees, annual fees, interchange fees, services fees, etc.

Non-interest expenses include employee salaries, benefits, branch and office rentals, loan loss provisions, utilities, professional fees, conference fees, etc.

Lower Efficiency Ratio is Better

Credit Unions should strive for lower efficiency ratio since lower ratio indicates how efficiently they are operating to generate income. Generally, a ratio of 50% is considered optimal efficiency ratio.

Why is it important?

Efficiency ratio is important for various reasons. It tells us how a given credit union is functioning.

  1. High-efficiency ratio indicates that a credit union is making lot of investment to generating income. Either the expenses are higher than usual or the income that is generated is less than usual. Quality of the loan portfolio, crumbling economy, losses of jobs by members can be underlying reasons why the income generated by the portfolio may be impacted leading to higher than optimal efficiency ratio.
  2. Low-Efficiency ratio might indicate that a credit union is more efficient. However, if the credit union is holding on making the appropriate investments in upgrading their infrastructure, technology investment, etc. then in the long term it may impact their operations. As long as the credit union is making appropriate investment to secure the future while maintaining the low-efficiency ratio, then they are moving in the right direction. 
  3.  50% is considered the maximum optimal efficiency ratio.

Star One is the Most Efficient Big Credit Union

Based on 5300 filing, as of 12/31/2017, Star One Credit Union is the most efficient Big 10 Credit Unions with the efficiency ratio of 26%.

Credit Union Name

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What it the Efficiency Ratio of your credit union?

As you can see efficiency ratio is one of the extremely easy formulae to help get a better understanding of your credit union. By no means, this should be considered an end-all, be-all financial metrics. There are other financial measures that should be used along with efficiency ratio to have a better understanding of the financial performance of a credit union.

What is the efficiency ratio of your credit union? Share here with the community.

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  • Vendor

    I would echo David's comments regarding the efficiency ratio.  It really is more of a financial metric than a productivity measure.  There are two shortcomings of the ratio.  First, it includes interest rates and rates are not productivity.  If margins are widening, efficiency improves, but productivity may actually be declining, so you get a false positive.  A false negative can occur if rates are compressing too.  I would also consider excluding PLL from the ratio, to reduce volatility and get a better read.  The second shortcoming is if you have a line of business that consumes no net worth, but throws off a decent profit margin, it can also make efficiency worse.  For example, if you have a large investment or insurance operation that runs at a 15% profit margin, it's really an 85% efficiency ratio.  It will create a drag on efficiency as the line of business grows, but because it consumes no capital, an unlimited amount of volume at 15% profit margin would be a great thing to have.  This same example would create a false negative reading on Expense to Assets.  Expense to assets counts all expense incurred in the generation of non-interest income but ignores the revenue.  A slightly better measure would be net operating expense to assets.  Bottom line:  There are a number of ways to look at “efficiency” and “productivity” and digging into each provides the most insight.

    • CU Employee CULytics Founder

      Hi Mike,

      Thanks for your comments. Few things that I will like to point out.

      1. Efficiency ratio is just one the factors to consider. It is by no means an end-all, be-all financial measure. 

      2. The efficiency ratio as mentioned in the blog does not include interest rates. It does not include interest expense. It is the ratio of Non-Interest Expense/Net Income. So, if the margins are widening because of lower interest expense then there is no impact on efficiency ratio.

      3. In your example, if there a slight twist. The large investment that runs at 85% efficiency and insurance operation that runs at 80% efficiency. Where should credit union focus its efforts? I would say, it depends. Since efficiency ratio is just one of factors to consider when making a decision. It depends on the size of the opportunity, competition, barriers to entry, and so on. However, efficiency ration is one of the factors to consider when making a decision.

      What are the key financial measures that credit unions should use to keep tab on their financial health? What are the top KPIs for looking into efficiency and productivity from your perspective?


    • Vendor

      Good comments by all.  I think we are in clear agreement that a "single" measure of efficiency or productivity is probably like sasquatch ... rumored to exist, but never proven.  Also, as Jon noted, the reason for your analysis drives what you use.

      Regarding your questions … assuming no capital requirement, I would pursue both the 85% and 80% efficiency opportunities with equal rigor.  Why?  The ROE is infinite … it can’t be computed because there is no capital required.  In a capital constrained industry (banks, credit unions) a source of income that does not require capital opens up other areas that do require capital (or provides a dividend opportunity).

      If I had only one measure of productivity, it would be the following: (non-interest expense less non-interest income) / (loan balance plus checking & savings account balance).  Effectively, it is net cost of operations per strategic balance dollar.  It is efficiency divided by effectiveness.  The lowest cost is the best.  I would exclude MMkt, CD and IRA from the denominator because they should require minimal resource to attract and manage.  Those funding sources are also rate sensitive – and because of that, have lower strategic value.  In the research I have done, the top third performers take less net interest spread from their members and at the same time, have a higher ROA, because of superior operating leverage.  The bottom third take the most net interest spread and have the lowest ROA, because of poor operating leverage.  Again, any single measure of productivity has its shortcomings, but this is my favorite when evaluating credit union performance.  For banks, my favorite is efficiency ratio as computed by FDIC formula because of the profit focus there.

  • CU Employee

    A couple of comments. Efficiency ratio can be a misleading measure of credit union operating efficiency, because credit unions return to their members "above the line" through higher rates on deposits, lower rates on loans, and lower fees. Depending on member giveback, this can depress reported income. Expense/Assets may be a better measure of relative efficiency. I would also challenge the assertion that 50% is the optimum efficiency ratio. The efficiency ratio is driven by several factors, including operating model. At Alliant, for example, our relatively low operating expense derives from a low-cost acquisition model (SEG and word of mouth) and high member reliance on remote and self-service channel access. This hasn't prevented us from investing in talent and technology, nor has it limited growth, and giveback is in the top 2% of credit unions.

    • CU Employee CULytics Founder

      Hi David,

      Interesting perspective.

      1, What are your thoughts on using Efficiency Ratio for comparing branches and/or products to get a better sense of how they are performing?

      2. I have been thinking more of non-interest expense/Assets as a measure. This measure will favor credit unions where members have higher balances, since then credit unions have to serve less members for the same asset size, which reduces their non-interest expenses. Looking back, even Efficiency Ration tends to favor credit unions where members have higher balances. 

      Interestingly, with this StarOne is still the most efficient credit union. 

      CU Name Non-Interest Expenses over assets
      STATE EMPLOYEES' 1.96%
      PENTAGON 1.71%
      SCHOOLSFIRST 2.10%
      THE GOLDEN 1 2.41%
      ALLIANT 1.35%
      STAR ONE 0.62%


      3. Another metric might be interesting is non-interest expense/member, which shows how much a credit union is spending to service each member.

      cu_Name Non-Interest Expense Per Member
      STATE EMPLOYEES'  $ 318.89
      PENTAGON  $ 239.62
      BOEING EMPLOYEES  $ 392.86
      SCHOOLSFIRST  $ 367.02
      THE GOLDEN 1  $ 294.68
      FIRST TECHNOLOGY  $ 503.30
      ALLIANT  $ 344.55
      SECURITY SERVICE  $ 372.96
      STAR ONE  $ 563.86


    • CU Employee

      I think the problem with using efficiency ratio for evaluating branches is accurately determining revenue or asset attribution. What revenue/assets are directly attributable to a given branch? With products, the challenge is cost attribution.

      Your observation about higher average balances is correct. Also, revenue (adjusted for giveback) tends to be a function of balances, while operating expense is a function of number of members, so it makes sense that CUs with higher average balances would be more efficient - i.e., generate more revenue relative to expense.

      I agree that a better relative efficiency measure for CUs is non-interest expense/assets. And yes, it tends to be correlated with efficiency ratio for the reasons above.

      I agree that non-interest expense/member is a useful metric for managing productivity.

    • Vendor

      Interesting comments. My original commentary was focused on branch dependent financial services firms. Different business models that are more dependent on digital or mobiile channels might yield different efficiency ratios. I agree that the efficiency ratio is not necessarily a productivity measure, and certainly not the only measure one should look at when examining their business, but it is a telling metric. Higher rates are an incremental expense and can either be seen as a "member benefit" or a "cost of doing business". If you were a bank instead of a credit union, and you offered higher rates, it would be seen as a cost of doing business. Shareholder dividends would be the equivalent of member giveback.

      Average cost to serve a member is an interesting metric. The bottom line with any retail branch-dependent FI is that it has a heavy fixed infrastructure cost, so like any fixed-cost business needs big customer volumes to first meet those breakeven expense levels, but anything above those levels yields higher profitability, which can be returned to members. One other point. My short speech on this topic was limited to 12 minutes so I was unable to go into the nuances of all the other key metrics one should examine. Perhaps at a future event I can expound on these topics in greater detail.


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