Net Interest Margin (NIM) is a tool to measure the profitability of a firm, highlighting the difference between interest earned and interest paid. Knowing NIM can help you as an investor assess the profitability of financial service companies like banks, non-banking financial companies (NBFCs), and investment firms. Typically, financial institutions receive interest on loans and pay interest on deposits, savings, and so on. So, if you are contemplating a bank or NBFC stock purchase, NIM is a valuable metric for you to consider during stock analysis.
How do you calculate Net Interest Margin?
The steps involved in NIM computation are as follows:
- Compute total interest income and interest expenditure in a given fiscal year
- Compute average income-generating assets using the formula below:
Average earning assets = [Beginning year asset balance + Ending year asset balance]/2
- Substitute the above-computed values in the NIM formula given below:
NIM = (Interest income – Interest expenditure) / Average income-generating assets X 100
NIM is expressed in the form of a percentage. Earning assets comprise stocks, debentures, bonds, certificate of deposits (CDs), rental property, notes, dividend-paying instruments, and so on.
Understanding how NIM is calculated
Suppose a bank receives an interest income of Rs. 20,00,000 and incurs interest expenditure of Rs. 16,50,000 in FY 2020-21. The opening and closing balances of its earning assets are Rs. 30,00,000 and Rs. 36,00,000, respectively. How to calculate NIM of the bank?
Substituting values from the given example in the formulae mentioned above:
Average earning assets = (30,00,000 + 36,00,000)/2 = 66,00,000/2 = Rs. 33,00,000
NIM = [(20,00,000 – 16,50,000) / 33,00,000] X 100
= [3,50,000 / 33,00,000] X 100
= 0.1061 X 100
= 10.61%
The bank has a positive NIM of 10.61%. It implies that for every investment of Rs. 100, the bank earned profits of approximately Rs. 11.
What are the most significant implications of NIM?
- A positive NIM implies that an organisation has invested efficiently and garnered net profits
- A negative NIM indicates investment inefficiency. The organisation’s liabilities outweigh its investments resulting in a net loss. In other words, its interest income is unable to cover the cost of its debts
Why is NIM important for you?
- NIM is one of the profitability indicators that you should ideally consider while buying bank or NBFC stocks
- It helps in assessing a financial institution’s NPAs (non-performing assets). The higher the NPA, the lower will be NIM and vice-versa.
If you wish to invest in the stock market, you should opt for a bank or NBFC stock with a positive NIM. If you are wondering which are the top stocks to buy today, it is a good practice to analyse NIMs of different banks and financial institutions.
Make NIM your ally while investing
NIM is a profitability ratio that assesses the effectiveness of a firm’s, especially a financial institution’s, investment decisions. It also aids you in stock selection. However, if analyzing and interpreting data isn’t your forte, it is advisable to reach out to a financial advisor who can guide you in stock picking and your overall investment journey, based on your risk appetite and financial goals.