Banks are in the business of making money through lending and charging interest. While banks charge their customers interest, they also incur interest expenses. A bank's net interest margin is one of many indicators reflecting the health and stability of the institution. As a small-business owner, you want to do business with banks that are stable and making wise investments.
Understanding Net Interest Margin
Your small business probably takes advantage of a variety of financial services. You might take out a loan to acquire equipment and pay interest on that loan while you repay it, which your bank receives as interest income.
You probably also have a business savings account to help build a solid foundation for your business. Your bank pays you interest on that savings account, which is an interest expense for the bank. Interest income, interest expenses and average earning assets can be used to determine a bank's net interest margin, which shows whether a bank is making wise investments.
Net Interest Margin Formula
Once you obtain the interest income, interest expenses and average earning assets from the bank's income statement, you are ready to calculate the net interest margin. To do this, subtract the interest expenses from the interest income and then divide that number by the average earning assets.
For example, say you are hoping to include a particular bank in your investment portfolio. Its income statement discloses the following numbers:
- Investment income: $2,000,000
- Investment expenses: $1,500,000
- Earning assets: $20,000,000
You would start by subtracting investment expenses from investment income:
- $2,000,000 - $1,500,000 = $500,000
Then, divide that amount by the earning assets:
- $500,000/$20,000,000 = .025
The results of this equation conclude that this particular bank has a 2.5% net interest margin. It is making more money on its investments than it is losing on its interest expenses, which is good news for investors.
Net Interest Margin
The bank in this example is earning money on its investments, which is better than losing money. However, when it comes to net interest margin, higher is better for the bank. At the end of 2019, the Federal Reserve reported the national average net interest margin at 3.34%. This means that this hypothetical bank is a little below average.
Some of the banks reporting a higher than average net interest margin include:
- Discover Financial Services: 10.41%
- Capital One: 6.95%
- Byline Bancorp: 4.62%
- Glacier Bancorp: 4.39%
Factors Affecting Net Interest Margin
For banks, achieving a high net interest margin is dependent on more than simply making up their mind to make smart investments. Factors affecting net interest margin include the following:
- Supply and demand for savings accounts or loans
- The Fed raising the discount rate
- The Fed lowering the discount rate
- The Fed raising the funds rate
- The Fed lowering the funds rate
Certain institutions like Discover or Capital One offer a different range of financial services than most local banks. Their offerings are more dependent on high interest income with fewer interest expenses, which can sometimes result in a higher net interest margin.
Net Interest Margin vs. Spread
In financial circles, you'll probably hear people talking about net interest margin and net interest spread. The net interest rate spread is the difference between what a bank pays to consumers and what it receives in interest income.
For example, if a bank offers a 2.2% savings account but also charges home owners 6% for a home loan, the net interest spread is 3.8%. This number and net interest margin, return on equity, efficiency ratio and return on assets are vital indicators of institutional vitality.
- Investopedia: Net Interest Margin
- Investopedia: What Net Interest Margin is Typical for a Bank?
- Federal Reserve Bank of St. Louis: Net Interest Margin for All U.S. Banks
- BankRegData.com: Net Interest Margin
- Nasdaq: Glacier Bancorp, Inc. Announces Results for the Quarter Ended December 31, 2019
- Business Wire: Byline Bancorp, Inc. Reports Third Quarter 2019 Financial Results
- Capital One: Capital One Reports Fourth Quarter 2019 Net Income of $1.2 Billion, or $2.25 Per Share
- FRED Economic Data. "Net Interest Margin for all U.S. Banks." Accessed Aug. 26, 2020.
Anne Kinsey is an entrepreneur and business pioneer, who has ranked in the top 1% of the direct sales industry, growing a large team and earning the title of Senior Team Manager during her time with Jamberry. She is the nonprofit founder and executive director of Love Powered Life, as well as a Certified Trauma Recovery Coach, certified HRV biofeedback practitioner and freelance writer who has written for publications like Working Mother, the San Francisco Chronicle, the Houston Chronicle and Our Everyday Life. Anne works from her home office in rural North Carolina, where she resides with her husband and three children.