Beyond ROE : how to measure bank performance (appendix to the report on EU banking structures)

What is an acceptable level of return on equity (RoE) for a bank? This question is likely to play a pivotal role in the post-crisis debate among banking executives, investors and regulators. Following the spectacular losses in the financial crisis and the massive government intervention, there is little public support for banks returning RoE ratios of well above 20%, as these have mostly proved to be unsustainable. Recent events have shown that the most common measure for a bank's performance, i.e. RoE, is only part of the story, as a good level of RoE may either refl ect a good level of profi tability or more limited equity capital. In addition, although the "traditional" decomposition of the RoE measure (i.e. looking at banks' operational performance, risk profile and leverage) may have been useful to assess banks' performance during benign times, this approach has clearly not proven adequate in an environment of much higher volatility - such as during the global financial crisis, where RoE fluctuations have been caused entirely by operational performance, which does not aid our understanding of the potential trade-off between risk and return in performance. This may actually explain why some of the high-RoE firms have performed particularly poorly over the crisis, dragged down by a rapid leverage adjustment. Against this backdrop, there is obviously room for taking a step back from the rather consensual market valuation of performance through RoE and carrying out a more comprehensive assessment of banks' performance.