What is Net Interest Margin?

Net Interest Margin is a popular profitability ratio used by banks, which helps them determine the success of firms in investing in comparison to the expenses on the same investments and is calculated as Investment income minus interest expenses (this step is referred to as netting) divided by the average earning assets.

Net Interest Margin (NIM) Formula

This ratio talks about the NIM, meaning how much interest an investor receives over how much she pays out.

Here’s the formula.

When an investor invests money in bonds or other investment instruments, she gets a percentage of interest on her investments.

At the same time, if we assume that the money that is being invested is actually borrowed, then the investor (and the borrower) also need to pay interest to the lender of the money.

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In this formula, we are trying to find out the difference between the interest that is received and the interest that is paid. And then, we would compare the difference between the average invested assets to find out the proportion.

Average invested assets are the average of all the investments. We take average invested assets to find out the median of all invested assets so that we can ease out the differences among the invested assets.

Examples

Let’s take a simple example to illustrate this concept

You can download this Net Interest Margin Ratio Excel Template here – Net Interest Margin Ratio Excel Template

Xavier has been experimenting with different investment instruments. Recently he has tried a bunch of investments, and he wants to see how he is doing. He has borrowed $100,000 from the bank and invested the entire amount in an investment instrument. The bank is charging him a 10% simple interest on the loan. And he has been getting 9% quarterly compounded from the investment. Find out the NIM (if any).

In this scenario, we need to find out the interest rate for each side.

First, we will find out how much Xavier has to pay to the bank. And then, we will calculate the interest that Xavier will receive.

Xavier will pay = ($100,000 * 10%) = $10,000 to the bank.
And Xavier will receive at the end of the year = [$100,000 * (1 + 0.9/4)⁴ – 1)] = [$100,000 * (2.252 – 1)] = [$100,000 * 1.252] = $125,200 from the investment.
The interest received from the investment would be = ($125,200 – $100,000) = $25,200.

Using the Net Interest Margin formula, we get –

NIM = (Interest Received – Interest Paid) / Average Invested Assets
Or, NIM = ($25,200 – $10,000) / $100,000 = $15,200 / $100,000 = 15.2%.

Use of Net Interest Margin

This is a ratio every bank uses. It’s because banks are in the business of taking deposits from investors and then using the same money to earn interests in other investments.
NIM is one of the most common ratios used to compare the performance of the banks.
For an individual investor, the net interest margin would also be useful as she would be able to see how much she earns and how much she pays proportionately.
Actually, NIM is a measure of how well an investment strategy is executed. If the NIM is less, there is room for improvement, and if the NIM is well on target, then maybe the investor may continue with the same sort of investments (the range and the instruments, both).