The margin, when the product is money

The last post set up the bank’s P&L: interest earned, minus interest expended, equals net interest income (NII). That is the rupee figure. The question every analyst asks next is the same one asked of a manufacturer’s gross margin: as a percentage of what?

For a manufacturer the denominator is revenue. For a bank, the natural base is the pile of assets that earn the interest — the loans and the investment book. NII as a percentage of that pile is the net interest margin (NIM).

NIM  =  Net interest income  /  Average interest-earning assets

which decomposes into

Yield on assets   =  Interest earned    /  Average interest-earning assets
Cost of funds     =  Interest expended  /  Average (deposits + borrowings)
Spread            =  Yield on assets  −  Cost of funds

NIM and spread are close cousins but not identical: spread compares two different bases (earning assets vs. funding), NIM puts the net figure over one base. Banks quote NIM; analysts often back out the spread to see which side moved.

NIM Spread
What it is Net interest income as a % of earning assets Yield on assets minus cost of funds
Bases used One: average interest-earning assets Two: earning assets for the yield, deposits + borrowings for the cost
Counts assets funded by equity? Yes — they earn interest at no interest cost, which lifts NIM No — it compares rates only, not how much of each
Who quotes it Banks, in every results release Mostly analysts, backed out from the P&L
Best for The overall margin on the book Seeing whether lending rates or funding costs moved

When a bank’s earning assets are larger than its deposits and borrowings — the gap funded by its own equity, which costs no interest — NIM comes out above the spread. The worked example below shows that happening.

Two words in the formula matter enormously: average and interest-earning. The balance sheet is a snapshot at 31 March; the interest was earned over twelve months on whatever balances existed each day. Using year-end balances instead of averages, or total assets instead of the assets that actually earn interest, gives a different — usually lower — number. Which is exactly what happens below.

Worked example: HDFC Bank, FY25

From HDFC Bank’s results for the year ended 31 March 2025 (standalone, audited; released 21 April 2025). ₹ crore, historical, for illustration only.

Step 1 — the averages. Only two year-ends are in the filing, so the average is (opening + closing) / 2:

31 Mar 2024 31 Mar 2025 Average
Advances 24,84,861.52 26,19,608.61 25,52,235.06
Investments 7,02,414.96 8,36,359.68 7,69,387.32
Interest-earning assets (approx.)     33,21,622.38
Deposits 23,79,786.28 27,14,714.9 25,47,250.59
Borrowings 6,62,153.07 5,47,930.9 6,05,041.98
Funding     31,52,292.57
Total assets 36,17,623.06 39,10,198.94 37,63,911

Step 2 — the ratios:

Computation Result
Yield on interest-earning assets 3,00,517.04 / 33,21,622.38 9.05%
Cost of funds 1,77,846.95 / 31,52,292.57 5.64%
Spread 9.05 − 5.64 3.41%
NIM on interest-earning assets 1,22,670.09 / 33,21,622.38 3.69%
NIM on total assets 1,22,670.09 / 37,63,911 3.26%

So: the bank earned about 9.05% on what it lent and paid about 5.64% for the money, keeping a spread of roughly 3.41 percentage points — three-and-a-bit rupees out of every hundred lent, before running costs and bad loans.

Why the bank’s own number is different

HDFC Bank’s release quotes, for the March 2025 quarter:

“3.54% on total assets, and 3.73% based on interest earning assets. Excluding ₹ 7 bn of interest on income tax refund, core net interest margin was at 3.46% on total assets, and 3.65% based on interest earning assets.”

Our full-year figure on total assets is 3.26%, against the bank’s 3.54% for the quarter. The gap is not an error on either side. It comes from three things worth knowing, because they apply to every bank you’ll ever read:

  1. Averaging basis. The bank uses average daily balances; we used two year-end snapshots. When a balance sheet grows through the year, the two-point average can overstate the base and understate the margin.
  2. Period. The bank’s figure is for one quarter, annualised; ours is the whole year. Margins move within a year as rates change.
  3. Definition of the base. Our “interest-earning assets” is advances plus investments; the bank’s includes some balances with RBI and other banks that also earn interest, and excludes items that don’t. Note too that “interest earned” includes interest on bank balances and on tax refunds, which our narrower base leaves out.

The lesson isn’t that one number is right. It’s that NIM is only comparable on a stated basis — and a filing will usually tell you the basis if you read the footnote. Comparing Bank A’s “NIM on interest-earning assets” with Bank B’s “NIM on total assets” is comparing two different things.

Why 3.5% is a lot

A margin of three-and-a-half percent sounds like a rounding error next to Britannia’s 40.9% gross margin. The base makes the difference.

Average total assets of about ₹37.6 lakh crore, at a NIM of 3.26%, is ₹1.23 lakh crore of net interest income — ₹1,22,670.09 crore. Put another way: for every ₹1 lakh sitting on the balance sheet, the bank earned about ₹3,259 of net interest in the year.

It also means small moves are big money. If NIM had been 10 basis points (0.10 percentage points) lower for the year, NII would have been roughly ₹3,764 crore lower — about 5.6% of the year’s profit after tax, from a change most people would not notice in a headline. This is why bank results are reported, and read, in basis points.

🧒 Explain it like I'm 10 (optional — skip if this is already clear)

Suppose you run a stall that sells water bottles. You buy each bottle for ₹9.05 and sell it for… wait, no: you borrow each bottle for ₹5.64 a year and rent it out for ₹9.05 a year. You keep about ₹3.41 per bottle.

₹3.41 is not much. But say each bottle is a ₹100 bottle, and you are renting out ₹39 lakh crore worth of them. Suddenly ₹3.41 on every one is an enormous amount of money — and if the price of borrowing bottles goes up by just 10 paise, you lose a fortune.

That’s a bank. Tiny margin, unimaginable volume, and every paisa matters.

What moves NIM

NIM is not a fixed property of a bank; it moves with the interest-rate cycle, and the two sides of the spread move at different speeds.

  • Loans reprice faster than deposits when rates rise. Since October 2019 the RBI has required new floating-rate retail and MSME loans to be linked to an external benchmark (the repo rate, for example) under circular RBI/2019-20/53 of 4 September 2019, and those reset within months. Fixed deposits stay at the old rate until they mature. So when rates go up, yield rises before cost of funds does and NIM widens — temporarily.
  • The reverse when rates fall. Yields drop quickly; the bank is still paying last year’s deposit rates. NIM compresses, again temporarily.
  • Funding mix. A bank funded mostly by low-cost current and savings accounts has a structurally lower cost of funds than one funded by wholesale borrowings. That is the next post, on CASA.
  • Asset mix. Unsecured retail loans yield more than home loans, which yield more than government bonds. A bank can raise its NIM by lending riskier — which is not the same as being a better bank, and the NPA post later in this module is about the bill for that.

None of this says where HDFC Bank’s margin is going. It says what to watch when it moves.

Common mistakes

  • Comparing NIMs quoted on different bases. Total assets vs. interest-earning assets, quarterly vs. annual, reported vs. “core.” Read the footnote first.
  • Treating a rising NIM as pure good news. It can mean cheaper funding (good), a rate cycle that will reverse (temporary), or a shift into riskier lending (the cost arrives later, in provisions).
  • Computing NIM from year-end balances and calling it “the” NIM. As above: 3.26% vs. 3.54% from the same company and the same year. State the basis.
  • Ignoring the base. A bank with a lower NIM on a much larger, safer balance sheet can earn more, more reliably, than a bank with a higher NIM. Margin is one term of a product; the price-to-book post puts the terms together.

Takeaway: NIM is a bank’s gross margin — what it earns on what it lends minus what it pays for the money, on a base of lakhs of crores. The same NII can come out as 3.26% or 3.54% depending on the base and period, so the first question about any NIM is “measured on what?”