Net Interest Margin

The Net Interest Margin (or NIM) is one of the primary measures of a Bank Holding cropped-fredgraph4.pngCompany’s (BHC) capacity to generate revenue. NIM figures reported by individual banks can be found at  BankRegData.com and in aggregate at the St Louis Fed as displayed here in the FRED graph. The FRED graph shows the average NIM of the U.S. Bank Holding Companies. Notice that average NIM is close to a 30-year low at 300 basis points (or 3%). That means the difference in the lending rates (assets) and the deposit rates (liabilities) are  close to a minimum seen over the past 30 years.  The aggregate US commercial bank assets is 15.96T on 21 Oct. 2016 and the total reported liabilities  is 14.21T on 12 Oct. 2016. Nearly half of assets ~7.3T reside in a handful of the largest BHCs: JPM, Wells. BofA. Citi, US Bancorp, and PNC. For a bank with the assets the size of JPM a 1 basis point (bp) increase in the NIM generates an additional ~$200MM  annual revenue.

Numerous factors drive the NIM level, perhaps the most important one is that at the end of the business day the value of the BHC’s assets and liabilities+equity  must be equal according to GAAP, IASB, and FASAB. This is also referred to informally as the “assets must be funded.” The bank may use transfer pricing to allocate capital within the firm so that funding assets may be broken down into several smaller processes. For example, a global bank might use transfer pricing for capital allocation between Asia, Western Europe, South America, and North America.  Finally, the bank generally has a capital allocation plan for new funds and excess cash flow from the banking book (or accrual portfolio). The capital plan may also allocate funds for hedging the interest rate, credit, and FX risk in the banking book.  The timing and selection of acquiring assets and liabilities, maintaining new capital reserve levels, the efficiency of the capital allocation plan implementation in light of market movements, as well as the market performance of the roll-over accrual portfolio inventory  are important factors determining the NIM level.

 

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