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In this article, Luiz Zorzella explains how understanding the net interest margins will better inform your business strategy.  

If you are a bank executive and want to manage the bank’s business strategically, you must understand the key drivers of your bank’s profitability and the trade-offs they imply.

For example, to some extent, banks can trade the cost of deposits for efficiency ratio by making it more convenient for clients to make deposits.

At the same time, the equilibrium of these trade-offs depends on a number of external factors which change all the time. In our example, while the status of the labor market impacts banks’ efficiency ratio, the compression of interest rates impacts the attractiveness of low-cost deposits.

Take interest rates for example. In 2019 10YTs paid on average 2.14%. They then fell to 0.89% in 2020 (a 125 bps reduction) and up to 1.42% in 2021 (a 53 bps increase).

How the large banks’ NIM were impacted and how they responded to this?

The NIM of JP Morgan, Bank of America, and Citibank have been decreasing, having lost between one and one and a half percentage points in the same period. To put this in perspective, my rule of thumb is that banks need around one percentage point of NIM just to pay their cost of equity to hold banking assets, which is not accounted for in the NIM formula.

Loan yields have been significant drivers of this reduction – kind of. Take for example Bank of America. The bank’s NIM decreased by more than one percentage point even though its loan yield is now close to its 2019 level. The other two banks’ NIMs have also not mimicked the changes of their loan portfolio’s yield.

Key points include:

• The reduction of loan portfolio
• The role of deposit changes
• Average rate on deposits

Access the full article, How To Ace It Strategically By Understanding Your NIM, on Amquant.com.