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The Components of Margin

When evaluating the earnings performance of your financial institution, if you unravel the bank’s return measures, ROA and ROE, you quickly realize that the net interest margin is still the most significant factor in determining a bank’s profitability. A strong and consistent interest margin, regardless of the interest rate environment, allows a bank to absorb net overhead costs, provide for possible loan losses, pay income taxes, and return a respectable level of net income.

Expressed in dollars, margin is known as net interest income. Net interest income is interest income from all earning assets less interest expense on all interest bearing deposits and liabilities. Stated as a percentage of average earning assets, net interest income represents the bank’s interest income (tax equivalent basis) net of interest expense and is known as net interest margin.

By converting interest margin to a ratio, it can be easily compared to competitors and peers. The higher the interest margin ratio the more effective the bank is in managing its earning assets and interest bearing liabilities. A good margin ratio is reflective of good yields, lower cost rates, competent use of earning assets and a judicious mix of interest-bearing liabilities.

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