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RAPPORT

The return on equity..

of large Dutch banks.

The return on equity (RoE) of banks, a common measure of profitability, 9 is a hotly debated topic among banks and regulators. RoE is typically defined as net income divided by the book value of equity. Therefore, a bank’s RoE can be changed in two ways: through a change in net income or by operating with more or less equity.

In the run-up to the recent global financial crisis, banks increased the RoE by boosting income and operating with small capital buffers. This development was driven both by investor demands for higher returns and by a gradual loosening of regulatory standards. As a result, the RoE of many Western banks reached levels in excess of 15%. The strategies used to increase the RoE, which often involved more risk-taking, caused many banks to run into trouble once the financial crisis hit. For instance, banks operating with less equity were more likely to fail or to be in need of state support...

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