How to calculate cost-to-income ratio of a bank?

Cost-to-income ratio is calculated by dividing the operating expenses by the operating income generated i.e.net interest income plus the other income.

Cost-to-income ratio = Operating Expenses

                                     Operating Income

where, Operating Expenses = Employee Cost + Other Operating Expenses

Operating Income = Net Interest Income + Other Income

Cost-to-income ratio is important for determining the profitability of a bank. The ratio gives a clear view of how efficiently the bank is being run - the lower the ratio, the more profitable the bank. Changes in the ratio also highlight potential problems - if the ratio rises from one period to the next, it means that costs are rising at a higher rate than income. Thus there is an inverse relationship between the cost-to-income ratio and the bank's profitability.

Let us calculate the cost-to-income ratio for HDFC Bank for FY13 from the below data (extracted from its FY13 audited standalone financial results):

Thus, HDFC Bank’s cost-to-income ratio for FY13 is 49.58% which is 100 basis points lower than the level in FY12, indicating efficiency in performance.

Let us consider another example – Punjab National Bank (extract of its audited standalone FY13 financial results):

Thus, for PNB, cost-to income ratio has deteriorated in FY13 i.e. it incurred higher cost (42.811 paise for every rupee earned during the year, as against 39.75 paise incurred in FY12 to earn a rupee).