Banking: Importance of Net Interest Margins

The business of bank is to accept deposits and lend advances. Hence, it is very important to know the spread between them in order to judge a bank’s profitability and growth. Net Interest Margin (NIM) is the spread of the interest earned and the interest expended by the bank. A bank's NIM is calculated as follows - its Net Interest Income divided by its average earning assets (which includes advances, investments, cash and balances with the RBI and call money). Thus, NIM is one of the key indicators that need to be watched while analysing banking stocks.

Banks with a higher CASA (Current Account and Savings Account) ratio usually have higher NIM, as the cost associated with CASA is very less (no interest is paid on Current Account, while minimum interest is paid on the Savings Account). Now, with the Savings Account interest rate getting deregulated, the low cost deposits comprise only Current Accounts.

Traditionally, there is a positive correlation between the Yield Curve and NIM. The Yield Curve is the spread between the govt.'s short-term and long-term rates. Banks generally offer deposits rates, which are based on the short-term rates, and extend loans based on long-term rates. If the Yield Curve gets contracted, the banks' NIM also come under pressure, and vice-versa.   

The following table shows the NIM of various banks:

Generally, the NIM of banks gets affected in a rising interest rate environment, as the rise in the cost of deposits is not fully transferred at the time of lending. But the bank which manages to transfer the cost of deposits to customers has power over them.

According to an RBI report entitled 'Trend and Progress of Banking in India 2010-11', the NIM of the Indian banking sector continues to be higher than that in some of the emerging market economies of the world. On one hand, an increase in NIM increases the profitability of the banks, but on the other, it increases the cost of financial intermediation in the economy. So, a balanced approach must be taken , with profitability and efficiency in mind.