# Interest margin

Interest margin is a business metric in banking that can be used to measure the profitability of a credit institution .

## General

In industry and commerce , profitability is measured using the return on sales . Since bank turnover is not important in the banking industry and does not have to be shown in the profit and loss account , a different reference value must be selected. The balance sheet total represents the interest-bearing activities of a credit institution most closely, so banking management opted for this measure. It is an expression of the relative competitive strength and the achieved market position. In addition, there is an even more meaningful parameter, the business volume , which is derived from the balance sheet total plus the contingent liabilities .

As early as 1934, Josef Flock published a book on the interest margin in commercial credit unions, followed in 1936 by Werner Hotzel with another work on the interest margin in the entire banking sector.

## Calculation and types

Credit institutions generate net interest income through lending (lending business ) and deposit business (deposit business ). Short-term and lower-interest deposits contrast with loans with a longer term and interest ( structural contribution ). In addition, the lending rate of the banks is higher or the deposit rate is lower than the comparable interest rate on the capital market ( conditional contribution ). The interest income to be taken into account when calculating the interest margin is made up of the interest income from lending and money market transactions as well as fixed-income securities and debt register claims. If you compare this interest income with the balance sheet total or the business volume, the ratio is the gross interest margin :

${\ displaystyle {\ text {Gross interest margin}} = {\ frac {\ text {Interest income}} {\ text {Balance sheet total or business volume}}} \ cdot 100 \, \%}$

The interest margin is therefore nothing more than the difference between the volume-weighted borrowing rate of the lending business and the volume-weighted credit interest rate for cash investments and central bank money. If the interest income is netted against the interest expenses , the result is the interest result or the interest surplus. If you compare this interest result with the balance sheet total or the business volume, the net interest margin results :

${\ displaystyle {\ text {Net interest margin}} = {\ frac {\ text {Interest income-Interest expenses}} {\ text {Balance sheet total or business volume}}} \ cdot 100 \, \%}$

In order to also obtain a flow variable in the denominator , the average balance sheet total is selected, which results from the opening balance and closing balance on the balance sheet date :

${\ displaystyle {\ text {avg. Balance sheet total}} = {\ frac {\ text {opening balance + closing balance}} {\ text {2}}}}$

## Expressiveness

The interest margin is the most important source of success for credit institutions. The higher the interest margin, the more favorable the profitability of a credit institution is. The amount of the interest margin influences the possibility of retaining profits and thus the ability of a bank to self-finance to increase its equity autonomously - without using the capital market . The net interest margin provides information about the margin of the interest-bearing banking business , i.e. the trading margin that exists between the refinancing costs paid on the liabilities side and the interest rate achieved on the assets side. An autonomous increase in the interest margin sought by the credit institution can therefore only be achieved by improving the margin, i.e. increasing the debit interest and / or lowering the credit interest.

However, the market interest rate, which cannot be influenced by the individual credit institution, has the greatest influence on the interest margin. If the active fixed-interest positions (fixed-interest loans) predominate at a credit institution, the interest margin will decrease if the market interest rate rises because the variable interest expenses increase without the interest income being able to be adjusted; this is where the interest margin risk materializes . The determinants of this interest margin risk are fixed interest surpluses and fixed interest gaps, since in the case of an asset surplus or a passive fixed interest gap this different interest rate adjustment behavior with rising interest rates necessarily leads to a decrease in the interest margin and vice versa. The interest margin is also reduced accordingly if a bank cannot adjust long-term passive fixed-interest transactions when the market interest rate falls. A high interest margin can, on the one hand, indicate excessive credit risks and, on the other hand , suggest investors with little bargaining power . If a bank has high bargaining power in both lending and deposit business, its interest margins can increase. If the balance sheet total grows faster than the net interest income, the interest margins decrease. Rising interest spreads can also be attributed to increases in equity, as lower interest-bearing refinancing is required.

On the other hand, intense regional competition among banks is causing their interest margins to fall. The interest margin is higher, the more inelastic the liabilities side and the more elastic the assets side reacts to changes in interest rates. The interest margin only does not change if there is an elastic equilibrium in which the average active interest rate reacts to changes in the reference interest rate in the same way as the average liability interest rate; Changes in the interest rate level - regardless of the direction - then have no impact on the interest margin.

## Interest spreads in banking competition

The interest margin serves the board of directors of a credit institution as a basis for decision-making in margin policy and in determining profitability and competitive intensity. In the banking competition, there are very different interest margins among the banking groups. They illustrate that the cooperative central banks and the Landesbanken have a structurally low interest margin, which is due in particular to the low-margin interbank and wholesale business operated by these banking groups . In the case of the savings banks and credit unions , which are well positioned in retail banking , the interest margin tends to be larger. The Deutsche Bundesbank has determined for small and medium-sized banks that an increase in the 10-year interest rate by one percentage point results in an increase in interest income of 0.57 percentage points, while interest expenses only increase by 0.25 percentage points; this increases the interest margin by 0.32 percentage points. From this it can be concluded that the interest margin increases with an increase in the interest rate level and vice versa. This is an indication of the accusation of the media that when the market interest rate rises, the credit institutions first increase the lending interest and only later (or not at all) the interest on the liabilities side and vice versa.

If the interest margin is added to the commission margin, the result is the gross profit margin .