Net interest margins is a performance metric of banking or non banking finance entities signifying the difference between the interest income earned on loans and advances and interest paid-off to the lenders or for deposits in comparison to average total interest-bearing assets.
Computation of NIM
Net Interest Margin (%)= Interest earned by banks on loans-Interest paid to lenders or deposits/ Avg. Total assets
For ex.: If the bank's average total interest-bearing assets equal to INR 100 in one year's time and it generated an interest income equivalent to INR 5 and paid-off interest amounting to INR 2.
Then, NIM= INR 5-INR 2 / INR 100 =3%
Further, NIM is also a measure of the banking concern's appropriateness with respect to its investment decisions. A positive NIM is illustrative of the banking concerns right decisions with regard to investments whereas a negative NIM implies banking institutions inappropriate business and investment decisions.
Significance of NIM
NIM expressed in % terms is a significant measure indicating the bank's profitability or health of the banking institution. The positive NIM is indicative of the bank's proper channelization of its liabilities or deposits that generates significant interest income from growth in credit. However, negative NIM is indicative of the bank's failure in the proper deployment of its resources or poor lending and credit growth.
Furthermore, the NIM of a bank witnesses a decline with the increase in the non-performing assets of a bank as the average total income-bearing assets go down.
Net Interest Margin of Banks from investors point of view
From investor's standpoint, NIM holds paramount importance and they need to monitor the relative net interest margins for parking their money in the banking sector. As an higher NIM of the bank would also provide for higher valuation of the concern. Also, it can also be used as a measure to adjudge the banking entity's relative improvement or decline in margins over the years.