Big and small banks, is size, the key? Elucidated through key benchmarks

The banking industry has undergone a tremendous amount of change in the past 8 years as a result of the 2008 financial crisis. During this period, many small and large banks performed badly, several were bailed out and various others changed their business strategies and operating models. These steps were taken in order to accommodate cost saving measures and enforce stricter regulations. However, the degree, method and impact differed in large and small banks.

The small banks generally thrive on local community’s knowledge, product customization and strong client relation management, with their thin network of ATMs or branches. Further, most of their income is generated through traditional banking business such as taking deposits and giving loans. On the other hand, large banks are full-service universal banks. They function like a huge multinational corporation, having multiple arms or segments, including bancassurance, investment and advisory services, wealth management services and the likes other than the traditional banking service. The large banks provide commoditized products with ease of access to their customers, through their wide network of branches and ATMs.

                                                                                                                                              Source: Televisory Analysis

It is due to the difference in the business model of large vs. small banks, the factors that affect them are different. For instance, the quality of customer service in small banks would depend on the degree of product, fees, interest rate customization offered, the value derived from customers and customer retention ability. However, quality of service for large banks would be a factor of ease of access to products via multiple branches/ATM network, comfort in transferring accounts, efficiency of the online portal, and quick redressal of customer grievances. Moreover, financial and operational benchmarks need to be interpreted depending on the size of the bank. Let us reflect on few vital parameters for small and large banks and how it affects their profitability.

Net Interest Income to Total Operating Income

Since traditional banking is the core of smaller banks, this ratio will be higher for them in comparison to their big banking counterparts. Further, a higher net interest margin plays a more important role in determining profitability and return on equity for small banks than their larger compeers.

Non-Interest Income to Total Operating Income

This ratio would be higher for large banks as they have multiple fee-generating business segments. Small banks focus on interest income and thus, have inadequate or no fee-generating services.

Allowance for loan losses to total loans

Small banks would have a higher allowance for loan losses as even a few loan defaults could easily affect profitability in any given period. Additionally, small banks are mostly not completely hedged leaving them more prone to default risk. Thus, small banks practice cautious lending and focus on knowing their customers better than large banks. 

Note: Data is annualised as of Q3 2015 for US Banking Industry

Source: FDIC Q3 2015 Quarterly banking Profile

The above table displays interesting facts – the sweet spot for the optimum economic size lies somewhere in the middle – neither too large nor too small.

Selling, General and Administration Cost to Total Cost

The large banks spend more on mass advertising and hence, their selling costs are higher than the small banks. In addition, technology related costs are higher in large banks as they have to spend more on IT system to integrate their different and complex business processes. Additionally, the advent of big data analytics and smart banking solutions would further increase such costs with the large banking institutions. Moreover, regulatory compliance costs are also higher in the larger banks as the “too-big-to-fail” are given more attention and they need to follow additional compliance procedures to ensure industry stability. It should be noted, that increased technology convergence and regulatory compliance costs impact profitability of the small banks more than the large banks due to a limited availability of funds for small banks.

Loan to Assets Ratio

While high loans to assets ratio translate into a high return on equity for both categories, it must be noted that a large portion of assets in small banks consists of fixed assets that are invested in their small branch network. Hence, a higher loan to assets ratio among small banks would indicate fewer branches. Large banks run on purchased capital funds. Therefore, a higher loan to assets would translate into higher ROE directly.  A very high loan to asset ratio indicates higher risks of liquidity that a bank may face in the event of any ‘run on bank’.


The small banks normally have an above average liquidity that impacts the availability of funds for profit generation. Conversely, large banks have low liquidity as they have a better inter-banking system and easy access to central bank funds, in a case of a liquidity crunch.


The large banks are more leveraged and risk takers as compared to the small banks. Further, capital ratios at the large banks are much lower in comparison to the small banks. Thus, it is imperative for the large banks to adhere to heightened and strict regulatory practices as a failure of a large banking institution may have a greater impact on the stability of the financial system. This does not mean failures of the small banks can be ignored, multiple setbacks from the small banks are an equal cause of concern for the regulators and governing agencies, alike to a large bank.

Therefore, is size, the key in determining the success or profitability? We do not think so.

Irrespective of the size, to remain successful, bankers need to ensure growth in an industry that is witnessing a flat revenue trend. The larger banks are likely to struggle harder than the smaller banks, with respect to register growth. As, they grapple with regulatory issues, high litigation costs, technology expenses, high leverage and low capital ratios. At the same time, large banks need to de-risk their business models and rebuild their brand image by concentrating on their core strengths while divesting in other businesses. The small banks are far less complex and need to focus on cost saving measures. This is required to mitigate much-needed and increased costs related to technology and regulatory compliance.

In conclusion, banks that are able to strike a balance between increasing revenue and reducing or maintaining risk exposures are the ones that emerge successful in the long-run.

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