What time is it?? It’s metric time!!
This month we’re talking about Net Interest Margin (NIM). If you have clients in banking and consumer lending, how is it measured and why is it meaningful? Read on….
Who uses it?
NIM is one of the key metrics for Banks, and for those who want to evaluate the performance of a bank’s investmentsHow is it measured?
Expressed as a percentage, NIM = (Interest income – Interest Expense) / Average Earning Assets where:
- Interest Income is all of the interest earned on a Bank’s loans and short term investments
- Interest Expense is the cost of the funds used to make the loans and investments
- Average Earning Assets is the average of all of the assets that generate interest income
NIM is the measure of the difference between generated interest income and the amount of interest paid out to their lenders.
Why is it important?
NIM is one of the basic ratios to evaluate a bank’s performance. Think about NIM as similar to the gross margin of a good and services company. At a quick glance, the NIM is an indicator of the effectiveness of a Bank’s investing strategy for its interest-bearing assets. NIM is not an overall measure of profitability, because banks earn revenues through non-interest income as well.
What drives it?
Some of the biggest drivers of NIM that a bank can manage are:
- the mix of interest-earning assets – the more higher yielding assets, the higher the NIM
- pricing competition – cheaper lending rates and higher deposit interest for customers erode NIM
- quality of loan portfolio – banks need to provision for under-performing assets. The more funds that are put aside for bad loans, the less is available to invest, which decreases NIM
What's the Goal?
The goal is to optimize the NIM. For banks whose income is largely interest income, the goal is to optimize interest income by finding ways to maximize the spread between how much interest income they’re generating and how much they’re paying out. For other banks, the goal may be to minimize the impact of NIM performance by generating non-interest income through fees for services, account maintenance, insufficient funds, and the like.
So how do you translate this into conversation about value with your clients?
We’ll follow this up on Thursday with The KPI Connection, connecting this month’s metric to key business processes and ultimately measurable impact on your clients’ business, so check back for that.