Thread: Cost of Funds & Net Interest Margins
COF is the implied interest rate paid by the bank on the funds that it uses in it's business. Banks get these funds from sources like Savings & Current Accounts (Cheapest sources), Fixed Deposits, Bonds, Debt instruments etc.
COF is the implied interest rate paid by the bank on the funds that it uses in it's business. Banks get these funds from sources like Savings & Current Accounts (Cheapest sources), Fixed Deposits, Bonds, Debt instruments etc.
Eg: A Bank has deposits of Rs. 100 (on which it pays 6%) and bonds of Rs. 100 paying 7% and thus the weighted average cost of funds for them comes to be 6.5%. In a nutshell, it is the cost of funds.
Now the bank has to lend money at a rate higher than its COF to make profits.
Now the bank has to lend money at a rate higher than its COF to make profits.
This profit margin is denoted by Net Interest Margins (NIM)
Let's understand NIMs:
Net Interest Margin is difference between investment returns earned and interest paid divided by Average Earning Assets.
Let's understand NIMs:
Net Interest Margin is difference between investment returns earned and interest paid divided by Average Earning Assets.
Suppose total income earned by bank is Rs. 100 on the assets of Rs. 1,000. Also the bank has to pay Rs. 70 on its liabilities.
NIM will be 100-70/1000 = 3%.
Preference should be given to a bank which has stable NIM along with stable asset quality (lower NPA ratios)
NIM will be 100-70/1000 = 3%.
Preference should be given to a bank which has stable NIM along with stable asset quality (lower NPA ratios)
Tip: Banks have access to savings & current accounts which is low cost funds for banks, This is not available to NBFC's and so the COF of NBFC's is higher than Banks. Banks make decent NIM by lending cautiously however NBFC's have to lend at higher rate to maintain the NIM.
