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The IUP Journal of Bank Management

Does Higher NIM Cause Cost Complacency and Credit Delinquency?

Article Details

Pub. Date	: May, 2021
Product Name	: The IUP Journal of Bank Management
Product Type	: Article
Product Code	: IJBM10521
Author Name	:Ashish Srivastava
Availability	: YES
Subject/Domain	: Finance
Download Format	: PDF Format
No. of Pages	: 16

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Abstract

This paper examines the importance of Net Interest Margin (NIM) for banks' profitability and investigates whether the banks with higher NIM face cost complacency and suffer from adverse selection in their credit decisions and hence, higher Non-Performing Assets (NPAs). It evaluates the relationship of the level of NIM with the banks' wage and nonwage operating expenditure, Cost-Income Ratio (CIR) and gross NPA for scheduled commercial private sector banks and scheduled/non-scheduled Urban Cooperative Banks (UCBs) in India. The analysis shows that NIM has a significant positive impact on the profitability of banks. For scheduled commercial private sector banks, the gross NPA has the most profound negative impact on their profitability. For UCBs, the most significant negative impact comes from wage CIR. For none of the banks, credit delinquency increases with a higher NIM. While operating cost per rupee of assets is seen at an elevated level for banks with a higher NIM, the impact of the higher cost is more than offset by the increased income, and hence, the paper shows that NIM is one of the important determinants of bank's profitability and a higher NIM does not necessarily cause cost complacency and credit delinquency.

Introduction

Banks are specialized entities offering financial intermediation between savers and users of funds by accepting public deposits and using such funds for making loans and investments. This process of maturity and liquidity transformation happens at a cost in the form of interest payable to depositors and recoverable from borrowers. The difference between the interest paid to depositors and the interest charged on the borrowers, which is naturally higher, creates a spread called net interest income, which is the difference between interest earned and interest expended by a bank. Net Interest Margin (NIM) as a ratio of net interest income to assets (or, to be more precise, average interest-earning assets) is a widely recognized component of a bank's earnings and profitability. It depends on both the quantum, composition and pricing of the bank's assets and liabilities to provide a cover for the cost of financial intermediation. Besides, NIM works as a crucial part of a bank's fund intermediation process and serves as a