Net Interest Margin (NIM)

Net interest margin (NIM) is the difference between interest received and interest owed to borrowers. This is a calculation comparing the net interest income that a financial institution earns from credit products such as loans and mortgages, with the outgoing interest this owes to savings account holders and deposit certificates (CDs). It is an industry-specific profitability ratio which lends interest-earning assets to banks and other financial institutions.

The NIM is a profitability indicator, expressed as a percentage that approximates the likelihood of a bank or investment firm thriving over the long haul. It is usually expressed as a percentage of what the institution earns on loans in an exceedingly period of time and other assets minus the interest paid on borrowed funds divided by the common amount of the assets on which it earned income in this period of time (the average earning assets). This metric helps prospective investors determine whether or to not invest in a very given financial services firm by providing visibility into the profitability of their interest income versus their interest expenses.

A positive net interest margin suggests the bank is spending effectively while a negative net interest margin indicates inefficient investment. A firm may take corrective action in the latter scenario by applying funds to outstanding debt or shifting those assets to more profitable investments. Net interest margin is comparable in concept to net interest spread, but the web interest spread is that the nominal average difference between the borrowing and therefore the lending rates, without compensating for the actual fact that the earning assets and therefore the borrowed funds could also be different instruments and differ in volume.

Net Interest Margin (NIM) Formula:

Net Interest Margin = Investment returns (IR) – Interest expenses (IE) / Average Earning Assets

Here,

  • Interest Revenue – Interest revenue is generated by interest payments on unpaid loans which the bank receives. This is composed of lines of credit and loans on the balance sheet of the financial institution.
  • Interest Expense – For a lending deal, interest expense is the amount the lender charges the borrower. Borrowing money is the cost. It is the interest accumulating on outstanding obligations. Customer deposits and wholesale financing are common examples.
  • Average Earning Assets – Earning assets of a business are investments that generate profits on the part of its owner, without any substantial effort. Some popular earning assets are inventories, bonds, deposit certificates, bills, etc. To measure the total accumulated assets, simply take the beginning and ending asset balance averages.

The Net Interest Margin is calculated as a percentage of net interest income over a specified period to average interest-earning assets. Monetary policy and monetary regulation can impact a bank’s net interest margin because the direction of interest rates dictates whether consumers borrow or save. The net interest margin of monetary intermediaries is directly associated with interest rates within the economy. Interest rates within the economy move in step with the economy’s trade cycle. A significant think about the online interest margin is whether or not there’s a greater demand for borrowing or saving. Consumers are more likely to borrow money and less likely to save it when interest rates are low. Through time this usually results in higher rates of net interest. Contrary to this, as interest rates increase, loans are more costly, making savings a more appealing choice, thereby raising the net interest margins.

With a bank or financial institution in particular, if the bank or financial institution has a large amount of unsuccessful assets (such as loans where full repayment is in doubt), its net interest margin (NIM) will usually decrease because interest received on unsuccessful assets is handled, for accounting purposes, as repayment of principal and not payment of interest thanks to the uncertainty that the loan are going to be fully repaid. Most retail banks offer interest on deposits from customers, which generally hovers around 1 percent per annum. When interest rates rise, the demand for savings accounts rises relative to loans, and the margin of net interest falls. That is because the bank would have more interest payments than receivable interest payments.

 

Information Sources:

  1. investopedia.com
  2. corporatefinanceinstitute.com
  3. wikipedia