Public sector Dena Bank’s net interest margin, or NIM, for fiscal 2009 dropped to 2.45 percentage points from 2.75 percentage points in the previous year because of reduced loan rates. Private sector lender ICICI Bank Ltd, on the other hand, has been able to raise its NIM from 2.2 percentage points to 2.4 percentage points. It has done so by raising its current and savings accounts, or CASA, from 26% of its overall deposits in 2008 to 28.7% in 2009. It wants to raise its CASA to 33% in 2010.
NIM and CASA are an integral part of every Indian banker’s vocabulary these days and analysts are busy dissecting these two parameters to gauge a bank’s profitability. How is NIM measured and what’s the connection between NIM and CASA or, for that matter, NIM and a bank’s loan rates?
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NIM and “spread” are the two key parameters that give an indication of a bank’s operational efficiency. As a concept, NIM and spread are very similar, but there is a subtle difference between the two. While NIM is arrived at by dividing a bank’s net interest income by its average interest-earning assets, spread is the margin between the yield on assets and the cost of liabilities, or the difference between interest income and interest expense as a percentage of assets. NIM can be higher or lower than the net interest spread.
When a bank cuts its loan rate, its interest income declines, and if it’s not able to cut its deposit rates by an identical margin, its NIM gets affected. Normally, in a rising interest rate scenario, banks are in a hurry to raise their loan rates, but slow in offering higher interest to depositors. Conversely, when the rates move southwards, banks are quick to cut their deposit rates, but they take time when it comes to passing on the benefit to borrowers. There is a reason behind this. The impact of any hike or cut in loan rates is felt immediately as a bank’s entire loan book is repriced, but that’s not the case with deposits as the new rates are applicable only when the existing deposits mature or new deposits flow in.
Indeed, CASA plays an important role in lowering the cost of deposits. The “CA” of CASA, or current account, is primarily meant for companies, public enterprises and entrepreneurs who have numerous banking transactions daily. Such accounts are cheque-operated and a customer can deposit or withdraw any amount of money any number of times. Banks generally insist on a higher minimum balance to be maintained in a current account and as it involves many transactions and the balances maintained in the account are too volatile, banks generally levy certain service charges for operating a CA. The money kept in such an account comes free to a bank as no interest is paid on current accounts.
A savings account, or the “SA” of CASA, is the most common operating account for individuals and others for non-commercial transactions. Banks generally put a ceiling on the total number of withdrawals permitted and stipulate a certain minimum balance to be maintained in such accounts. The savings account rate is currently pegged at 3.5%, but the average cost of banks is around 2.8% as banks pay interest only on the minimum balance kept between the 10th and the end of a month.
No wonder, then, that every bank wants to increase its CASA, as a higher portion of CASA in the overall deposit liability brings down its cost of money. Among private lenders, Axis Bank Ltd has the maximum CASA, some 46%, followed by HDFC Bank Ltd, 44.4%. Among public sector banks, State Bank of India and Punjab National Bank have high CASA ratios, at least 40% of their total deposits. The cost of CASA will go up from April 2010 when banks will have to pay interest on the daily balance in SAs, which means banks will have to pay 3.5% on savings deposits instead of the 2.8% they have been paying. The Indian banking system’s deposit liability is Rs39 trillion, and roughly 26% of the pile is in savings accounts. This means the banking system will have pay Rs7,000 crore extra to its savings bank account holders. This is one-fourth of the profits of public sector banks in fiscal 2009.
HDFCBank has an NIM of 4.2%, probably the highest in the Indian banking industry. IDBI Bank Ltd’s 1.06% NIM is the lowest. A high NIM alone cannot make a bank profitable as a substantial portion of NIM can be eroded by operating expenses and credit costs, including provisions for bad assets and write-offs. The operating expenses of public sector banks, which account for about 75% of the Indian banking industry in terms of assets, is higher than their private sector peers, at least 2% of assets. Their wage bill accounts for three-fourths of operating expenses. The wage bill of private banks is much lower, but their overall overhead costs, too, are not very low. The average cost of making provisions and writing off bad assets has been low in the past few years, less than 0.5% of total assets, but it will go up as banks are likely to pile up stressed assets with the slowdown denting borrowers’ ability to repay loans. So, banks need to cut their operating cost and increase efficiency. Also, despite a dropping NIM, they can remain profitable provided they start generating more fee income.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as a deputy managing editor of Mint. Please email comments to firstname.lastname@example.org