The most basic function of a bank is to take deposits and lend money. In order to make profit banks usually charge higher interest while lending money and pay less interest on deposits. The difference between the interest earned from loan and interest on deposits is called net interest income or bank’s core business income.
In this article, you will learn what is the net interest margin (NIM), how to calculate it and what NIM of a bank or financial institution tells you.
What is the net interest margin?
Net interest margin (NIM) is an industry specific profitability measure comparing the difference between interest paid and interest received by a bank or financial institution with the total assets.
In other words, NIM tells you the amount of money a bank has earned in interest on loan compared to the amount of money it has paid in interest on deposits for a period.
Net interest margin is often referred to as NIM.
Here is the formula to calculate NIM;
Net Interest Margin (NIM) = Net interest income / Total assets
Where, net interest income = Interest earned – interest expenses
Net interest income of a bank measures the difference between the revenue earned by a bank’s interest bearing assets and the expenses associated with its interest bearing liabilities.
For a bank, loans and advances such as car loan, housing loan, mortgages and commercial loans given to customers are assets and deposits taken from customers are accounted as liabilities. The excess amount earned from interest earned on assets over the interest paid on liabilities is known as net interest income.
In simple words, Net Interest Margin (NIM) is the financial ratio used to analyse how much net interest income earned compared to its earning assets. Where net interest income is the difference between total loan interest and total interest on deposits. Therefore, the net interest margin (NIM) is calculated from the difference between total loan interest and total deposit interest compared to the total earning assets of the bank
Year-on-Year or Quarter-on-Quarter growth in net interest margin indicates that the bank is very efficient in making money.
Example: How NIM is calculated
For instance, say XYZ bank has made a loan equal to Rs 100 Crore rupees during the year 2022. It has generated Rs 5.5 Crore in interest income for the bank during the year 2022. In the same year, let’s say the bank has paid Rs 3.5 Crore in interest to its depositors.
In this case, the bank’s net interest margin for the year 2022 can be calculated by using following formula:
Net interest income = Interest income from loan – Interest expenses on deposits = Rs 5.5 Crore – Rs 3.5 Crore = 2 Crore
Net interest margin (NIM) = Net interest income / Loan given to customers = Rs 2 Crore / Rs 100 Crore = 0.02 or 2%.
NIM is not the bank’s net profit margin or profitability. Almost all the banks earn money from fees and service charges of various kinds. Profitability is the total income that the bank has earned after taking out total expenses from total revenue.
What net interest margin (NIM) tells you?
Bank’s core income is net interest. If you look at any bank’s income statement, you will find the first line as interest income earned by the bank is higher in comparison to fees and services income and other incomes shown.
Growth in net interest margin (NIM) shows that the bank has earned good profit period after period from its core business of lending.
In contrast, a fall in NIM indicates that the bank’s profitability is declining from its core business. Decline in NIM indicates that the bank or lender has been unable to make good use of its assets.
Number of factors can impact a bank’s profitability. Here are few important factors that has a direct impact on net interest margin of a bank;
- Monetary policy of banking regulation set by the central bank can impact the demand for deposits and loans, thereby net interest income gets affected. NIM is very sensitive to changes in interest rates by the central bank.
- Due to economic uncertainty if demand for loans decreases relative to demand for savings, then most likely the bank’s net interest margin will decrease. The opposite is true when the demand for loan increases and demand for saving decreases. This means supply and demand mismatch can impact the net interest margin of a bank.
- Quality of the loan portfolio is another most important factor affecting NIM, which can generate more money for a bank.
- Rise or fall in Non performing assets (NPAs) will have an impact on NIM. if a bank’s non performing assets are rising, interest earned will fall and the Net interest margin will decline due to higher interest expenses and low interest income. The opposite is also true when Non performing assets are decreasing, interest income will rise and NIM will increase.
Net interest margin (NIM) is considered as a significant factor to determine financial stability of a bank. In order to know a bank or financial institution’s total profitability, you have to consider other factors into account. A complete analysis of income statement might help you to know how profitable the bank or financial institution is.
