Question

Net interest margin can have an impact of the financial performance of the commercial banks.

(i) Define net interest margin since it acts as an important tool to the financial sector. (3 marks)

(ii) Explain FOUR main factors that influence the net interest margin of the banking sector. (12 marks)

Answer 1

i. NIM basically indicates the profitability impact over a commercial banks because it's a total of an amount of interest margin where banks earns interests charged over loans issued to the small businesses and individuals and this amount is compared with respect to the interest charged on the deposits. Lending money is the main business and interest is the amount one pays to the bank as a pay charged over a loan. The formula for calculating NIM is to subtract Interest Expense from Interest Income and divide the result with Total earning asset.

ii. 1. Inefficiency in Banking Operational Cost: Failure in leading the operational performance may throw the chances of existing relationships to be inefficiently handled, which may further lead to erode the NIM.

‬2. Default over the loans: This case will definitely impact on NIM if occurred. Loans with higher risk gives more chances to default which can become a liability to the Bank. Risks are dependent on project nature and most likely causes a failure in the case of a project failure. Hence, banks are expected to maintain higher NIM to pay off funding the risky projects.

3. Size of the Banks and it's Capital reserves : NIM is impacted by the size of the banks and by it's capital reserve ratio. Banks with larger scale of size could possibly be having higher credit ratings and NIM could be low in by this impact.

4.LDR Ratio: Loan to Deposit Ratio means , the ratio in between how much amount of money lent to the customers with respect to how much amount of money deposits have been made by the customers. If LDR increases NIM rate increases and vice versa.