The average return on equity (ROE) for companies in the U.S. banking industry in the third quarter of 2020 was 5.31%, according to the Federal Reserve Bank of St. Louis. The banking industry average ROE increased to approximately 14% in the third quarter of 2021.
ROE is a key profitability ratio that investors use to measure the amount of a company's income that is returned as shareholders' equity.The St. Louis Fed discontinued reporting banking industry ROE during the third quarter of 2020. For alternative data similar to the discontinued information, the St. Louis Fed suggests users review the FDIC Quarterly Banking Profile, which summarizes financial results for all FDIC-insured institutions.
Key Takeaways
- Return on equity (ROE) measures how efficient a corporation is at generating profit from money that investors have put into the business.
- Most nonfinancial companies focus on growing earnings per share (EPS), while ROE is the key metric for banks.
- Bank ROEs averaged in the mid-teens for over a decade—prior to Basel III passage in 2009.
- Between 2010 and 2019, U.S. banks average ROE ranged between approximately 5% and 12%.
- In the first quarter of 2020, the average return on equity (ROE) for all U.S. banks declined to 3.22% as the COVID-19 pandemic impacted the banking sector; ROE rebounded to approximately 14% in the third quarter of 2021.
Why Return on Equity (ROE) Matters
The return on equity (ROE) metric reveals how effectively a corporation is generating profit from the money that investors have put into the business. ROE is calculated by dividing net income by total shareholders' equity. ROE is a very effective metric for evaluating and comparing similar companies, providing a solid indication of earnings performance.
Average returns on equity vary significantly between industries, so it’s not advised to use ROE for cross-industry company comparisons. A higher return on equity indicates that a company is effectively using the contributions of equity investors to generate additional profits and return the profits to investors at an attractive level.
There is one inherent flaw with the ROE ratio, however. Companies with disproportionate amounts of debt in their capital structures show smaller bases of equity. In such a case, a relatively smaller amount of net income can still create a high ROE percentage from a more modest base of equity.
The average return on equity for banks often falls during recessions. This was the case during the financial crisis of 2007-2009 when bank ROE fell to -1.03% and again during the beginning of the coronavirus pandemic when ROE fell from 11.38% in the fourth quarter of 2019 to 3.22% in the first quarter of 2020.
Bank Return on Equity
While most corporations focus on earnings per share (EPS) growth, banks emphasize ROE. Investors have found that ROE is a much better metric at assessing the market value and growth of banks. This comes as the capital base for banks is different than conventional companies, where bank deposits are federally insured. As well, banks can offer interest on its deposits, which is a form of capital, that is well below rates other companies pay for capital. Banks are incentivized to focus on managing capital to maximize shareholder value versus growing earnings.
However, minimum capital requirements, such as Basel III, increased the amount of capital banks had to keep in hand. This has pushed ROEs down. As a result, average bank ROEs have been lower following the passage of the reform in 2009. From the early 1990s until the mid-2000s, banks averaged an ROE in the mid-teens. After Basel III, U.S. banks average ROE ranged between 5% and 12% from 2010 to 2020.
The St. Louis Federal Reserve discontinued reporting banking industry ROE after the third quarter of 2020, at which point the ROE was 5.31%.In its "Supervision and Regulation Report" issued in November 2021, the Federal Reserve reported average bank ROE was approximately 14% for the third quarter of 2021, a significant rebound in bank profitability that exceeded pre-COVID levels.
Examples of Bank Return on Equity
As of October 2021, some U.S. megabanks reported ROEs below the industry average. Bank of America (BAC) reported an 11.4% return on average common shareholder equity in its third-quarter 2021 financial report. For the third quarter 2021, Wells Fargo (WFC) reported an ROE of 11.1%, while JPMorgan Chase (JPM) exceeded industry averages when it reported an ROE of 18% for the same time period.
