Net Interest Income and Net Interest Margin Compared

A bank funds assets with liabilities. Some of those assets pay it interest and some pay it nothing at all; some of those liabilities charge it interest and some charge it very little. The difference between what the earning side brings in over a year and what the costing side takes out over the same year is one rupee amount, and that amount is a fact about the year with nothing debatable in it. Turning that amount into a rate requires choosing what to divide it by, and that single choice is the point at which two banks stop being comparable. Everything in this guide follows from those two sentences: the first measure is a subtraction, the second is a subtraction followed by a division, and almost every argument about bank margins is an argument about the divisor rather than about the bank.

What is net interest income, and what period does it cover?

Take the subtraction slowly. The order it is done in is the order the reported lines appear in, and working in that order avoids trouble later. In the stated year, interest earned by Suvarna Commercial Bank Limited came to Rs 18,600 crore. In that same stated year it paid interest of Rs 11,160 crore on the money it had taken in. Subtract the second from the first and Rs 7,440 crore is left. The remainder is net interest income for the year, and net interest income is the entire spread business of the bank reduced to one number.

There is a familiar version of this from elsewhere, and it is worth keeping because of the specific trap it shuts. A wholesaler buys a sack of rice at one price and sells it at another. The difference between the two is what the trading has produced before the shop rent, the electricity and the wastage are taken off. The trading difference is a real number, it is worth knowing, and it is nowhere near profit. Net interest income sits in exactly that position for a bank: real, arithmetically clean, and four lines above anything that could be called profit.

The word that does the quiet work in all of this is the period. All three figures, the interest earned, the interest expended and the difference between them, describe the same stated year. A figure taken from one window and subtracted from a figure taken from another window is not net interest income and is not a margin either. The result is an arithmetic accident. This sounds obvious written down and it is not obvious in practice, because interest earned and interest expended often reach a reader from different places and different documents. Wherever the subtraction is done, both sides must carry the same period before the answer means anything.

What is net interest margin, and what exactly is it a percentage of?

Now define the second measure completely, before either is set against the other. Net interest margin (NIM) is net interest income divided by an asset base, expressed as a percentage and stated for a period. The sentence is the whole definition, and notice how much of it is unfinished: the phrase an asset base is doing an enormous amount of work and the definition does not say which base. The definition cannot say. More than one answer is defensible, and the person who publishes the number chooses.

So a margin has three parts rather than two. There is a numerator, the rupee amount for the year. There is a denominator, a stock of assets measured at a point or averaged across the year. And there is a period, without which a rate means nothing. A margin quoted with no base named beside it is not a wrong number, it is an unfinished one, and the difference matters because an unfinished number is usually read as a finished one. Everything else in this guide is an unpacking of that sentence.

Which bank assets actually earn interest, and which earn nothing?

Sort the asset side into two piles rather than into categories. For this purpose the only question worth asking about an asset is whether it pays the bank interest. AdvancesThe money a bank has lent out and expects back, carried on its balance sheet as an asset. Lending criteria and the decision behind them are settled separately. of Rs 1,44,000 crore earn interest. InvestmentsThe securities a bank holds rather than the loans it has made. Which securities, and why a bank holds them at all, are settled separately. of Rs 60,000 crore earn interest. Add the two and Rs 2,04,000 crore of the balance sheet is doing the earning. Total assets are Rs 2,40,000 crore, so by subtraction Rs 36,000 crore of the balance sheet earns the bank nothing in interest at all.

The third block holds balances at the central bank, cash sitting in the tills, the premises, the equipment and the other odds and ends a working bank has to carry. The nature of those assets and the reason a bank has to hold them are settled separately. The block is real rather than waste: a bank that shrank it to nothing would not be a better bank, it would be a bank that had stopped being able to operate. Think of a shopkeeper who has to keep some cash in the drawer to make change. The float earns nothing. Calling the float dead money misunderstands what it is for.

Which bank liabilities actually cost interest, and which cost nothing?

Now do the same sorting on the other side, and again sort by the bill rather than by the label. Deposits of Rs 1,92,000 crore cost interest, and they cost very different amounts depending on which kind they are: current and savings balancesDeposits that can be withdrawn on demand rather than being contracted to stay for a period. The size of this pool at any one bank is settled separately. make up Rs 80,640 crore of that total, while Rs 1,11,360 crore of it is locked into term depositsMoney placed with the bank on the understanding that it stays put for a fixed length of time, priced when it goes in rather than repriced while it sits.. Other liabilities of Rs 24,000 crore cost interest too. And net worthThe residue that would belong to the shareholders once every asset fetched its carrying value and every liability was paid off. A leftover, not a pot of money kept anywhere. of Rs 24,000 crore costs nothing in interest, which is precisely why it never appears anywhere in interest expended.

The asymmetry between the two sides is the thing to carry away. Charging a borrower more is a negotiation with somebody who can walk down the road. Paying a depositor less is often nothing more than leaving a balance where it already sits. Which is why the composition of the funding, and not the ambition of the lending, is usually what moves a bank margin. Deposit composition and what it costs are taken apart properly under deposit composition; here it is enough to know that the composition exists and that it is the lever.

One more thing about the funding, stated with its base and its caveat in the same breath. A careful reader gets caught here more often than anywhere else on the funding side. Interest expended of Rs 11,160 crore divided by deposits of Rs 1,92,000 crore is 5.81 per cent for the year. Read that as an upper bound rather than as what the deposits actually cost. The division has just tipped the entire bill onto the depositors when some part of it was created by the Rs 24,000 crore of borrowings and sundry liabilities standing next to them. The record carries no split of the interest bill, so the division rests on the figures that exist and states what it assumes.

Why does the same bank read 3.65 per cent and 3.10 per cent at once?

Here is the base rule, printed beside the numbers rather than tucked into a caution underneath them. Suvarna Commercial Bank Limited earned net interest income of Rs 7,440 crore across the stated year. The earning base is Rs 1,44,000 crore of advances added to Rs 60,000 crore of investments, a total of Rs 2,04,000 crore. Set the Rs 7,440 crore over that base and the margin comes out at 3.65 per cent for the year. Divide the very same Rs 7,440 crore by total assets of Rs 2,40,000 crore and the margin is 3.10 per cent for the year. Both divisions are arithmetically correct. The two readings are about 0.55 percentage points apart. Nothing about the bank changed between the two readings, and the whole of the difference is that Rs 36,000 crore sitting outside both the advances and the investments.

The strangeness of this shows up in the wild. Somebody who hands over two margins and asks which bank is better has handed over two divisions and called them two banks. The numerator is a fact and the denominator is a choice, and a printed percentage hides which choice was made. The everyday version: two people each say they spend a quarter of their money on rent. One means a quarter of what lands in the account and the other means a quarter of what is left after tax. Both are honest, both are useless side by side, and the sentence they said aloud was identical.

What identity closes the gap between the two margins?

The gap is not mysterious and it is not a disagreement. The gap is a stated fraction, and once the fraction is known the two numbers convert into each other exactly. Earning assets come to Rs 2,04,000 crore against a balance sheet of Rs 2,40,000 crore, putting the earning share at 85.0 per cent. The margin on earning assets multiplied by that share is the margin on total assets.

The rounding point is worth an extra beat. Rounding is the kind of thing that makes a reader distrust arithmetic that is actually sound. An identity holds between the quantities. The two-decimal versions that appear in print are not the quantities. Checked on the printed figures it lands one four-hundredth of a point away, which looks like something broken. Checked on the division itself, Rs 7,440 crore over Rs 2,04,000 crore, it lands on the nose. The same discipline saves a great deal of confusion everywhere else that a reported ratio is rebuilt from other reported ratios.

How are both measures built from the reported lines?

Build them in the order a reader would build them, and divide everything in front of yourself rather than quoting a figure somebody else divided. The table below does the whole thing in six steps. Nothing in it is quoted; every row is either a reported line or the row above it worked on.

Two figures, one numerator, six honest steps. Look once more at what feeds step 2. Deposits stand at Rs 1,92,000 crore, four fifths of the balance sheet at 80.0 per cent. Inside that total the current and savings balances account for 42.0 per cent, or Rs 80,640 crore, and Rs 1,11,360 crore sits on term. Every division above lands to the rupee, and none of it travels one inch beyond this bank in this year. Both halves matter together. A reader who keeps only the first will carry these percentages somewhere they do not belong. One bank in one year carries no trend and no ranking, and a rate struck on one balance sheet belongs to that balance sheet alone. The arithmetic is the lesson. The figures are merely what the arithmetic was performed on.

What does a retail bank mix do to the two measures?

A retail bank mix, in the narrow sense used here, means a great many small deposit relationships sitting beside a great many small advances. Two things follow, and only one of them touches the margin. A large number of small current and savings balances is the cheapest funding a bank can hold, and that lifts the margin. A large number of small advances costs more to administer, and that never touches the margin at all: operating costs sit below it.

The everyday version is ten shops in one shopping arcade, each paying a small monthly float into the same branch. No single float is worth much. None of them is negotiated. Together they are a large, stable and very cheap pool of money, and the person running each shop is thinking about stock rather than about the rate on the balance. The arrangement makes the funding cheap for one reason: not cleverness at the bank, but the fact that a small balance kept for convenience is not a balance anybody shops around with.

What does a corporate bank mix do to the two measures?

Now the mirror. A corporate bank mix, again in the narrow sense used here, means fewer and larger deposit relationships and fewer and larger advances. A single balance is worth the phone call, so large depositors negotiate. So more of the funding sits in term deposits paying a stated rate for a stated period, and the margin is pressed down. The advance, meanwhile, is cheaper per rupee to administer. The saving lands in operating expenses and never touches the margin either.

Here is the trap that this pair exists to set and then disarm: a lower margin is not a worse business, it is a different mix, and the operating cost line is where the difference between the two actually shows up. Ranking two banks on margin alone ranks them on funding composition while appearing to rank them on lending. Which composition is preferable is not something the record here settles: it carries one deposit split for one bank and no figure at all for either mix.

What does open banking change about where a cheap balance sits?

Open bankingAn arrangement under which a customer can let another provider reach the customer own account data. Who may run such an arrangement, and what a permission must satisfy, are settled by the regulator. means a bank makes a customer own data reachable, with that customer permission, by another provider. Note what is in that sentence and what is not. There is data, there is a permission and there is a second provider. There is no rupee anywhere in it: an open banking arrangement does not move a single rupee of deposits on the day it goes live.

So why does it appear in a discussion of margins at all? Because of what it does to the path rather than to the balance. The arrangement makes a balance easier to see, easier to compare against somewhere else, and therefore easier to move. The balance sitting at the end of that shortened path is precisely the cheap current or savings balance the margin depends on most. An arrangement that moves no money is a margin question for that reason alone. Who may operate such an arrangement, what a customer permission has to satisfy and what a provider may do with what it receives are all set by the Reserve Bank of India, and they move. Open banking set against a consent based data sharing arrangement is covered separately.

Net interest income vs net interest margin: which one survives a comparison?

With both measures now defined in full, the two can be set against each other. Net interest income compares two banks only if they are the same size, and they never are. Net interest margin compares two banks only if both struck it on the same base. A reader is rarely in a position to assume as much.

The working rule fits in one sentence. Read the income to see the scale of the earnings, read the margin to see the rate, and before setting one bank margin against another, find the base each one used. The everyday version: two households both put away Rs 5,000/- a month. The amount says nothing worth having until the earnings of each household are known, and it says something different again once they are. Neither number is the wrong number. The two numbers answer different questions, and the mistake is asking one of them the other question.

What does the margin leave out entirely?

Both measures in this guide stop at the spread. Fee and other incomeEverything a bank earns that is not interest: fees, commissions, gains on what it holds and so on. The contents of that line are settled separately. sit outside them. Operating expenses sit outside them. ProvisionsAmounts set aside against advances the bank may not fully recover. When and how much are set by the regulator, not chosen freely. sit outside them. Tax sits outside them. Following the bank down its own income statement shows how much distance that covers: it starts at Rs 7,440 crore of net interest income, adds Rs 2,400 crore of other income to reach Rs 9,840 crore of total income, takes Rs 5,040 crore of operating expenses off that for Rs 4,800 crore of operating profit, takes Rs 1,800 crore of provisions off that for Rs 3,000 crore of profit before tax, hands over Rs 750 crore as tax at 25.0 per cent, and Rs 2,250 crore of profit after tax is what survives the descent. A margin is the top of the income statement and not the whole of it.

One derived line is worth naming while the figures are still to hand. The retail and corporate difference actually lands there. The cost to income ratioOperating expenses measured against total income for the same period. The ratio answers a different question from the margin and is settled separately. here is Rs 5,040 crore over total income of Rs 9,840 crore, which is 51.22 per cent for the year. The cost to income ratio is the line where a mix that costs more to administer shows up, and that cost is invisible in both margins. A reader who ranks two banks on margin and never looks at this line has looked at the top of the statement and called it the business.

What this record does not carry, named rather than filled in

One bank, one year, and a short list of things a reader might reasonably want next and cannot have. Each row below is an absence rather than an omission, and each one costs this guide something specific.

Each of those rows names a gap rather than filling it. A figure invented to plug a hole would sit among the reported lines looking exactly like one of them. One neighbouring idea is worth a sentence while the discipline is fresh, even though the asset quality figures themselves are covered separately: a gross ratio is struck on gross advances and a net ratio on net advances, so that pair carries two different denominators for the same reason the two margins here do.

How does a credit analyst actually use these two numbers?

Watch what somebody paid to read banks does with this pair. The method is not what a first look suggests. The analyst does not start with the margin. The starting point is net interest income and its two parents, since the rupee amount gives the scale of the spread business and the two parents show how it got there: a bank whose interest earned grew and whose interest expended grew faster has a different year from one where both fell. Only then do they take the ratio, and the first thing they do with a published margin is not read it but look for the base. If the base is not printed, they compute their own from the balance sheet lines and use that, and they use the same base for every bank they are looking at. The base being consistent across the comparison matters far more than which base was chosen.

A lender to a bank, meaning somebody buying its bonds or placing a large deposit with it, uses the pair differently again. A lender cares whether the spread is wide enough to absorb the provisions in a bad year, and sets net interest income against provisions rather than against assets: Rs 7,440 crore against Rs 1,800 crore on this record, which tells them the spread covered the charge four times over in the stated year and tells them nothing whatever about the next one. A household reads the same idea from the other side of the counter. The rate on a savings balance and the rate on a loan sit on opposite ends of the same spread, and the gap between them is the bank margin measured one customer at a time. Understanding the measure does not make anybody a better customer of any particular bank.