Banking
Bank intermediation
A bank earns a spread by funding loans with deposits, and thin capital turns a small asset loss into a large loss of equity.
Definition
Bank intermediation is the business of standing between savers and borrowers: taking deposits that can be withdrawn on demand and making loans that are repaid slowly. The bank charges borrowers more than it pays depositors, and keeps the difference.
Because only a thin slice of the balance sheet is equity, the model is efficient and fragile at the same time. A small percentage loss on assets can wipe out a much larger percentage of capital.
Intuition
The bank sells liquidity to depositors and patience to borrowers, and the spread is the fee for holding the mismatch between the two.
When to use it
- Reading a bank, non-bank financial institution, or microfinance balance sheet.
- Judging whether a lending business earns enough spread to cover its losses.
- Explaining why capital regulation exists alongside profitability.
When not to use it
- For non-financial firms, where leverage is a financing choice rather than the core product.
- Treating a high NIM as good without checking the credit losses it is absorbing.
Formula
Net interest income
NII = (Earning assets × Asset yield) − (Funding × Funding cost)
The interest the bank keeps after paying for its funding.
- NII
- Net interest income
- Funding
- Interest-bearing liabilities
Formula
Net interest margin
NIM = NII ÷ Earning assets
The spread expressed as a percentage of money put to work.
Worked example
A small balance sheet
Loans of ৳8,00,000 earn 9% and are funded by ৳7,20,000 of deposits costing 4%. Operating costs are ৳20,000 and the tax rate is 25%.
- 1
Interest income
8,00,000 × 9% = ৳72,000.
- 2
Interest expense
7,20,000 × 4% = ৳28,800.
- 3
Net interest income
72,000 − 28,800 = ৳43,200, a NIM of 5.4%.
- 4
Profit
43,200 − 20,000 = 23,200 pre-tax; 17,400 after tax.
ROA is about 2.18% on ৳8,00,000 of assets, but ROE is 21.75% on ৳80,000 of equity, because leverage multiplies the result.
Common mistakes
- Comparing return on assets across banks without adjusting for risk weights.
- Reading a wide NIM as efficiency when it may simply be lending to riskier borrowers.
- Forgetting that deposits are liabilities owed back, not revenue.
How it connects
is part of
The source is a component of the target idea.
- Credit risk and expected loss: A bank's spread only makes sense once loss is priced in.
relates to
Useful to study together, in either order.
is an advanced form of
The source extends the target once the basics are secure.