Page 8 - Fall 2024_Neat

Does Scale in Banking Lead

to Profitability?
BY CHRIS NICHOLS

between three related asset
There are many experts who claim that to achieve
bands of bank size. Banks in
profitability, community banks (banks under $10B in assets) must gain $500mm-$1B, $1Bn-1.5B, and
scale by acquiring assets. On the surface that seems reasonable but $1.5B-$2B asset bands have
does scale in banking result in better performance for community remarkably similar efficiency
banks? The answer to that question can be analyzed both empirically ratios. We also observe similar
and anecdotally, and we believe that the answer is no – for community ROA among the three bands of
banks, there is no material relationship between size and performance banks. Therefore, empirical
as measured by return on assets (ROA) or return on equity (ROE). evidence does not show that a
Further, while we see no earnings accretion from community bank bank, for example that is $1B in
mergers, we do see a compelling case for refining the community bank assets, can improve efficiency
business model to allow scale to occur organically at the operating ratio or ROA simply by acquiring
level. another institution to reach $2B
in assets, because the average
The Data for Scale in Banking
performance and efficiency ratio
We can easily measure the correlation between bank performance
of $1B and $2B banks is similar.
(ROA or ROE) and bank size, and between efficiency ratio and bank
size. If there was a persuasive case to be made for community banks The two graphs below show Chris Nichols is Director of
getting bigger to enhance performance, we would see a strong efficiency ratios and ROA for Capital Markets at SouthState
correlation between bank size and ROA, and a strong correlation larger banks. Again, we see no Bank, an ACB Associate Member.
between bank size and efficiency ratio. The investment banking relationship between size and He can be reached at
argument is that gaining size spreads the overhead cost of finance, lower efficiency ratio or higher cnichols@correspondent.
southstatebank.com
treasury, compliance, audit, etc., resulting in lower efficiency ratio and ROA – in fact, we see the
higher ROA – unfortunately, the numbers do not support this argument. opposite in this set of banks.
For Q2/24, we measured the correlation coefficient between the
efficiency ratio and ROA for banks between $100mm and $10Bn in
assets, removing the top and bottom 10% of performance outliers. The
correlation between the efficiency ratio and ROA is negative 0.74 – one
of the highest correlations that we have seen driving performance (next
to non-interest income and non-interest expense). This leads us to
believe that community banks with a lower efficiency ratio can achieve
higher performance. But does size lead to a lower efficiency ratio?
Analyzing the same data set for the correlation between asset size and
efficiency ratio, we observe that the correlation is negative 0.11. There
appears to be no relationship between community bank asset size and
efficiency ratio. Further, the correlation between asset size and ROA is
also not meaningful (at negative 0.02). Statistically, within the
community bank sector, we conclude that while efficiency ratio may be
a large driver of performance, asset size does not relate to either lower
efficiency ratio or higher performance.

As further evidence, the graph above shows the efficiency ratio

A RKANSAS | 8 | Fall 2024
COMMUNITY BANKER