Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Net Interest Margin

What it is:

Net interest margin is the ratio of net interest income to invested assets. 

How it works (Example):

Net interest margin is also known as "net yield on interest-earning assets." 

The formula for net interest margin is:

Net Interest Margin = (Interest Received - Interest Paid) / Average Invested Assets

Net interest margin is always expressed as a percentage. Let's look at an example:

Assume John borrows $1,000,000 and uses it to buy bonds of Company XYZ. The bonds pay 5% interest per year, or $50,000. The interest rate on the loan is 3%, or $30,000 per year. Using the formula above, John's net interest margin is:

Net Interest Margin = ($50,000 - $30,000) / $1,000,000 = 0.02 or 2%

A positive net interest margin means the investment strategy pays more interest than it costs. Conversely, if net interest margin is negative, it means the investment strategy costs more than it makes. 

Why it Matters:

Banks are keenly interested in their net interest margins because they lend at one rate and pay depositors at another. However, comparisons between net interest margins of different banks are not always useful because the nature of each bank's lending and deposit activities varies.

Net interest margin is a measure of an investing strategy's success, especially when investors are attempting to "arbitrage" the market by borrowing at a rate that they believe is below what their potential returns will be.