Banks operate by lending and investing cash to generate income, but they also have to pay interest to their savers and creditors. A bank's ability to make profit depends on how much its interest income exceeds its interest expenses -- a value known as net interest. Net interest margin is a percentage calculated from net interest that indicates a bank's return on interest-earning assets over a particular period.
Subtract total interest expenses from total interest income for the period in question. The result is net income. Interest income and expenses are items on a bank's income statement. Net interest income might already be calculated and listed on the income statement. If the period in question spans multiple income statements, add the net interest from each statement to calculate the total for the whole period. For example, if a bank made $1 million in interest income over the past year and had $800,000 in interest expesnes, its net interest is $1 million minus $800,000, or $200,000.
Calculate the bank's average interest-earning assets. Interest-earning assets are things like loans and investments made by a bank that generate interest income. Interest-earning assets are noted on a bank's balance sheet. Add up all interest-earning assets the company had on each balance sheet during the period in question and divide by the number of balance sheets you needed to cover the period. The result is the average interest-earning assets. For instance, if over the past year a bank had $9 million of interest-earning assets during the first six months and $11 million during the final six months, its average interest-earning assets for the year are $10 million.
Divide average interest-earning assets calculated in step 2 by net income calculated in step 1. The result is the net interest margin. Continuing the earlier example, dividing the bank's net interest income of $200,000 by the average interest-earning assets of $10 million gives a net interest margin of 0.02 or 2 percent.
Net interest margin is an indicator of the profitability of a bank's lending and investment practices, but it is not synonymous with profit. A bank can have income sources, such as account fees, as well as expenses that aren't included in the net interest margin.
- AlexRaths/iStock/Getty Images