De-jargoned | Net interest margin

It is important to look at relative NIMs to ascertain bank valuation

So far, HDFC Bank Ltd, IndusInd Bank Ltd, Development Credit Bank Ltd, Axis Bank Ltd, Bank of Baroda, Yes Bank Ltd and Indian Bank have declared their earnings for the September quarter of FY13. If you go through their results, you will come across the term net interest margin (NIM).

What it is

NIM shows the profitability of a bank and technically it is the net earnings of a bank or a financial institution relative to its interest earnings assets such as loans and advances. It is calculated as the ratio between difference in the interest income earned on advances and the amount of interest paid to customers on deposits, and average earning assets of the bank.

For instance, let us assume that X bank has an interest income of 150 and its interest expense is 100 and has an average earning assets of 1,000. Here, the NIM for X company would be 5%. A positive NIM means that the bank’s investment decision are on the right track.

However, if the NIM is in the negative it indicates that the company’s investment decisions are not appropriate. It shows that the company has actually lost money on expense more than what it has earned from its investments.

Why it is important

NIM acts as the pulse that can show you the health of the bank. If NIM is positive, it means that the bank is using its assets effectively and credit growth is over accretive than deposit growth. It gives you a clear picture of the bank’s profitability from use of borrowed funds, i.e. deposits.

Whereas a negative NIM means that the bank is not making the right business decisions. It simply means that the bank is not able to lend effectively. NIM is important for the banks because it is the main source of their income. Higher the margin, higher will be the profit for the bank.

What it means for you

For investors, it is important to look at relative NIMs to ascertain bank valuation. The valuation for a banking stock among other things also depends on the margin. Higher the margin, higher will be the valuation premium for the banking stock. It is also important to compare historically if a bank is able to maintain its margins, improve them or if the margin is declining.