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Keys to Operating an Exceptional Bank Revenue Risk Management Efficiency 3

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There are three interrelated challenges to operating an exceptional bank: a (1) revenue growth, (2) robust risk management, and (3) efficiency. (1) (2) (3) Efficiency Revenue Risk Management

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The first two, revenue growth and risk management, work against each other, as the fastest way for a bank to increase revenue is to lower credit standards. This allows a bank to write more loans, but exposes it to higher credit risk down the road. Efficiency Revenue Risk Management

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Efficiency Revenue Risk Management A bank accordingly must balance these two imperatives, generating enough revenue in the short-run to meet profitability targets (usually an ROE of 10% or more) w/out jeopardizing profitability over a longer stretch, during which the credit cycle is likely to turn down. =

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Banks can make this balancing act easier by keeping operating costs low. This is captured by the efficiency ratio, which reflects the percentage of a bank’s net revenue that’s consumed by expenses. Efficiency Revenue Risk Management

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Revenue Risk Management Because a bank with a low efficiency ratio presumably has a higher profit margin than its less efficient peers, it can afford to compete more aggressively for the most creditworthy borrowers. As such, efficient banks are able to reduce credit risk and dial up revenue growth. Efficiency

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Thus, if there’s one thing bankers and bank investors should keep at the forefront of their minds, it’s the importance of a low efficiency ratio. As the diagram illustrates, this serves as the foundation upon which exceptional banks are built. Efficiency Revenue Risk Management

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