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Measuring commercial bank profitability: proceed with caution

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  • R. Alton Gilbert
  • David C. Wheelock

Abstract

The federal tax code creates challenges for comparing the profit rates of different banks on a consistent basis. The earnings of banks that elect to operate under subchapter S of the federal tax code are not subject to federal corporate income tax, but shareholders of these "S-banks" are taxed on their pro rata share of the entire earnings of the bank. The number of banks electing subchapter S tax treatment has increased rapidly, especially among small banks. The authors use estimates of the federal corporate income tax that S-banks would pay if they were subject to the tax to show that the difference in the tax treatment of S-banks and other banks has a large impact on measures of U.S. banking system profitability. Further, the article shows that adjustment of S-bank earnings by estimates of federal income taxes to make them comparable with the earnings of other banks can markedly affect conclusions of studies that use net income as a measure of performance. Finally, the article shows that S-banks (even after their earnings are reduced by estimated federal taxes) tend to out-earn their peers; S-banks also tend to have higher earnings rates than their peers in the year before they elect S-bank status.

Suggested Citation

  • R. Alton Gilbert & David C. Wheelock, 2007. "Measuring commercial bank profitability: proceed with caution," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 515-532.
  • Handle: RePEc:fip:fedlrv:y:2007:i:nov:p:515-532:n:v.89no.6
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    References listed on IDEAS

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    1. Keeton, William & Kahn, George A. & Schroeder, Linda & Weiner, Stuart E., 2003. "The role of community banks in the U.S. economy," Economic Review, Federal Reserve Bank of Kansas City, issue Q II, pages 15-43.
    2. James Harvey & Jane Padget, 2000. "Subchapter S : a new tool for enhancing the value of community banks," Financial Industry Perspectives, Federal Reserve Bank of Kansas City, issue Dec, pages 17-32.
    3. Robert DeYoung & William Hunter & Gregory Udell, 2004. "The Past, Present, and Probable Future for Community Banks," Journal of Financial Services Research, Springer;Western Finance Association, vol. 25(2), pages 85-133, April.
    4. Scott E. Hein & Timothy W. Koch & Steven Scott MacDonald, 2005. "On the uniqueness of community banks," Economic Review, Federal Reserve Bank of Atlanta, issue Q 1, pages 15-36.
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    Cited by:

    1. Gaul, Lewis & Palvia, Ajay, 2013. "Are regulatory management evaluations informative about bank accounting returns and risk?," Journal of Economics and Business, Elsevier, vol. 66(C), pages 1-21.
    2. Hernández-Murillo, Rubén & Llobet, Gerard & Fuentes, Roberto, 2010. "Strategic online banking adoption," Journal of Banking & Finance, Elsevier, vol. 34(7), pages 1650-1663, July.
    3. Peter Westort & Russ Kashian & Richard Cummings, 2010. "Does ownership form in community banking impact profitability?," Managerial Finance, Emerald Group Publishing, vol. 36(2), pages 122-133, January.
    4. Banerjee, Sreejata & Velamuri, Malathi, 2015. "The conundrum of profitability versus soundness for banks by ownership type: Evidence from the Indian banking sector," Review of Financial Economics, Elsevier, vol. 26(C), pages 12-24.
    5. repec:eee:riibaf:v:45:y:2018:i:c:p:435-445 is not listed on IDEAS
    6. Hernández-Murillo, Rubén & Llobet, Gerard & Fuentes, Roberto, 2010. "Strategic online banking adoption," Journal of Banking & Finance, Elsevier, vol. 34(7), pages 1650-1663, July.

    More about this item

    Keywords

    Bank supervision ; Bank profits;

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies

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