Definition
Return on Equity (ROE) for Banks
For a bank, Return on Equity is net profit as a percentage of average shareholders' equity, reflecting the return generated on the capital owners have invested.
Bank ROE is driven by ROA multiplied by leverage (assets to equity). Because banks run high leverage, even a modest ROA can translate into a healthy ROE. A sustainable ROE in the mid-to-high teens is considered strong for Indian banks.
However, ROE must be read alongside capital adequacy. A bank can boost ROE by running thin on capital, but that raises risk and may force a dilutive equity raise later. The best franchises combine high ROE with comfortable CET1, showing they earn well without stretching their balance sheet.
Related terms
- Net Interest Margin (NIM)Net Interest Margin is the difference between the interest a bank earns on advances and investments and what it pays on deposits and borrowings, expressed as a percentage of average interest-earning assets.
- Common Equity Tier 1 (CET1)Common Equity Tier 1 is the highest-quality bank capital, consisting of paid-up equity shares, share premium and retained earnings, net of regulatory deductions.
- Return on Assets (ROA) for BanksFor a bank, Return on Assets is net profit as a percentage of average total assets, the cleanest cross-comparable measure of how efficiently a bank uses its balance sheet.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.