Here’s how Net Interest Income and Net Interest Margin can help you in picking banking stocks

Equities

By Nikhil KamathZerodha

Globally, a large portion of a commercial bank’s revenues is derived from Net Interest Income or NII. Typically, NII represents the difference in the interest earned from a bank’s lending activities to its customers and the interest paid to account holders or depositors.

A simple abbreviation of Net Interest Income: Interest Received- Interest Paid.

Net interest income between banks varies to a large extent depending on the type of loans, asset quality, change in the yield on interest-bearing assets and interest paid on deposits.

Generally, if banks have to earn a higher NII, the spread between rate sensitive assets should rise faster compared to rate sensitive liabilities.

Likewise, if the spread between rate sensitive assets and liabilities decline, the NII would also fall. In addition, NII’s can also be affected due to a rise or fall in Non- performing assets (NPA’s) over time.

Net Interest Margins (NIM) on the other hand is arrived at by dividing Net Interest Income with the Average income earned from interest producing assets such as loans and advances have given out to borrowers.

NIM= NII/ Average Interest Earning Assets

For calculation purposes, both NII and NIM are measured over a period of time; generally ranging from a quarter to a year and are highlighted in the bank’s quarterly results.

From 1st April 2016, The Reserve Bank of India launched the ‘Marginal Cost of Funds based Lending Rate (MCLR),’ replacing the earlier ‘Base Rate’ system for calculating lending rates by banks.

Under the current system, all banks sanctioning loans under floating rates will have to reset interest rates based on the MCLR rates. However, banks are allowed to decide the spread at which they intend to lend over and above the MCLR rates.

The decision by RBI should positively affect long-term borrowers, especially those with existing home loans. However, home loan subscribers will benefit only when the interest rate reset comes up, which can be a long wait especially if the lender has a reset period of one year.

According to Dun and Bradstreet, aggregate deposits of scheduled commercial banks in India rose to 15.9 percent in 2016- 17 from 9.3 percent in the previous financial year.

The rise was led by massive fund inflows post demonetization in November 2016. However, credit growth has not kept pace, slipping to 8.1 percent from 10.9 percent during a similar period.

Likewise, gross non- performing assets of banks increased from 7.5 percent in 2015- 16 to 9.6 percent at the end of March 2017. The ever-rising growth in stressed assets, particularly with PSU banks has put a lid on credit expansion and thereby profitability.

Net interest income reported by private sector banks expanded by more than 15 percent leading to total income rising by close to 16 percent when compared to PSU banks which reported a modest 3 percent growth in income following a flat NII for the year ending March 2017.

For investors considering investing in bank stocks, the easiest way to review the financials would be to analyse the NII and NIM and compare them with the earlier period.

Likewise, since NPA’s have a major impact on the bank’s NII, a comparative analysis of the non- performing assets will also help in identifying if the stock is fairly priced.

Disclaimer: The author is Co-founder & Head of trading, Zerodha. The views and investment tips expressed by the investment expert on Moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.