Friday, September 28, 2007

Net Interest Margin For UK Banks

How has Net Interest Margin performed for UK banks since 2000?

(not A Level)

The Net Interest Margin is basically related to the difference between interest on borrowing accounts and interest from savings account.

Net interest Margin is net interest income (interest earned minus interest paid on borrowed funds) as a percentage of earning assets (any asset, such as a loan, that generates interest income).

The net interest margin thus depends upon:

  1. Net interest spread expresses the average difference between borrowing and lending rates. It does not take into account that the amount of earning assets and borrowed funds may be different.
  2. Liquidity The amount of funds which have to be kept in non interest bearing accounts such as cash deposits at banks.
What Could cause a rise in the Net Interest Margin for UK Banks

1. Less Competition between banks

If there is less competition between banks they can charge more for borrowing and pay less for savings account.

However, in the UK, there has if anything been an increase in bank competition due to the rise of internet banking such as Egg, offering better interest rates on savings

2. Lower Liquidity ratio.

A lower liquidity ratio means more funds can be used to earn interest, rather than being kept in non interest bearing cash reserves.

For example, the concern over Northern Rock's liquidity means that Banks may have to increase their liquidity ratio and the amount of cash balances for immediate withdrawals.

3. Increased Use of Credit Cards and Bank Transfers

This may reduce demand for cash withdrawals. This will allow banks to have a lower liquidity ratio and therefore increase the net interest margin.

4. % of loan defaults.

If there is an increase in loan defaults then the interest earned will fall dramatically. The % of loan defaults in the UK has been relatively low because of the long period of economic expansion and stability.

Risk Premium

A risk premium on borrowing enables a bigger profit margin. See: Interest rate changes and risk

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