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The Drivers of Net Interest Margin for a Bank (Banks 101 Series)

November 07, 2012 | About:
Certain industries by virtue of their unique characteristics have proven to be stumbling blocks for investors, who are used to reading the financial statements of a typical goods and/or service business.

This is one of many in a series of articles where I reveal the nuts and bolts of investing in unique industries like banks, etc.

Net interest margin = net interest margin (NIM) = net interest income / average interest-earning assets

For a bank without significant capital markets and/or proprietary trading activities, NIM is the key to profitability for the bank.

The key drivers of a bank's net interest margin are:

Mix of interest-earning assets

- Banks with a larger proportion of high yield interest-earning assets, will have a higher net interest margin. Consumer banking is generally more profitable than corporate banking, e.g. credit cards versus corporate loans.

Sources of funds

- Retail deposits entail lower funding costs compared with wholesale deposits, but banks will chalk up higher operating costs though maintaining the distribution network of physical branches, ATMs and bank staff.

Pricing competition

- Aggressive price wars for credit cards and mortgage loans waged against competitors will hurt net interest margins. Also, funding costs increase if banks dangle higher interest rates to attract more deposits.

Quality of Loan Portfolio

- Provisions have to be made for non-performing assets.

In Closing

Investors should understand the drivers for net interest margins and select bank stocks with a history of stable consistent NIMs through different economic cycles.

About the author:

Mark Lin
Mark is a private value investor and runs the Cheapskate Investing website which borrows from the wisdom of value investing giants, using a systematic quantitative screening approach to filter the global stock markets for cheap deep-value cigar-butts and wide-moat compounders. He publishes value investing case studies, investment checklists, and potential stock ideas on the Cheapskate Investing blog. He is also a regular contributor to various value investing communities.

Visit Mark Lin's Website

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