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Context:

Indian Overseas Bank (IOB) implementing strategies to protect its net interest margin (NIM).

About Net Interest Margin (NIM)

It measures how a bank is managing its core business: borrowing money at a lower cost and lending it at a higher rate. A healthy NIM indicates a profitable and stable bank.

In simple terms, NIM is the difference between the interest income a bank earns and the interest it pays out, expressed as a percentage of its interest-earning assets.

NIM = (Interest Income - Interest Expense) / Average Earning Assets

• Interest Income: This is the revenue a bank earns from its assets. The primary sources are interest on loans (home, auto, personal, corporate), investments in government securities, and other interest-bearing assets.
• Interest Expense: This is the cost a bank incurs for its funds. The main expense is the interest paid to customers on their deposits (Savings Accounts, Fixed Deposits) and interest on money borrowed from other sources, including the RBI.
• Average Earning Assets: This is the average value of the assets that actually generate interest. It excludes non-earning assets like cash held in vaults, bank buildings, furniture, or balances held with the RBI under the Cash Reserve Ratio (CRR).

Factors That Influence a Bank's NIM

RBI's Monetary Policy => Changes in the policy repo rate have a direct impact. When the RBI cuts the repo rate, banks are expected to lower their lending rates. If their deposit rates don't fall as quickly, their NIM can get compressed. In a rising rate environment, NIMs can expand if loan rates rise faster than deposit rates.

Cost of Funds  => A bank's ability to attract low-cost deposits is crucial. A higher CASA ratio (share of Current Account and Savings Account deposits) is highly beneficial, as banks pay very low or no interest on these funds. This reduces their overall Interest Expense and boosts NIM.

Yield on Assets => The mix of loans matters. High-risk loans like personal loans and credit cards carry higher interest rates (higher yield), which can increase NIM. Safer loans like mortgages have lower yields.

Credit Risk => While lending to riskier sectors can increase interest income, it also increases the risk of defaults (Non-Performing Assets or NPAs). When a loan becomes an NPA, the bank has to stop recognizing interest income on it, which directly hurts the NIM.

Competition => In a highly competitive banking sector, banks may be forced to offer lower interest rates on loans or higher rates on deposits to attract and retain customers. This competition puts downward pressure on NIMs.  

Operational Efficiency => A bank that manages its interest rate risk effectively and minimizes its non-interest operational costs is better positioned to protect its margins.

Why are NIMs Under Pressure?

Intense Competition for Deposits => Banks are aggressively competing to raise funds. To attract depositors, many have had to increase the interest rates offered on Fixed Deposits. This directly increases their "Interest Expense."

Intense Competition for Loans => At the same time, there is strong competition in the lending market, especially for high-quality corporate and retail borrowers. This limits the ability of banks to charge high interest rates on their loans, putting a cap on their "Interest Income."

How Banks Protect Their NIMs?

Focus on CASA Mobilization => They launch campaigns to attract more customers to open savings and current accounts to lower their average cost of funds.

Shift Lending Focus => They may increase their focus on high-yield retail loans, MSME loans, and agricultural loans, which offer better margins.

Manage Deposit Rates => They strategically adjust the interest rates offered on new fixed deposits to align with the new, lower lending rates.

Strengthen Recovery Processes => By improving the recovery of bad loans (NPAs), they can convert non-earning assets back into earning assets, which supports the NIM.

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Source: 

THE HINDU BUSINESSLINE