Net interest margins

Find out about net interest margins - the way banks make money from the difference between the interest they pay on deposits and the interest they receive on loans.

Banks make money by charging interest on the money they lend out, as loans, mortgages, overdrafts and credit cards.

They also usually pay out interest, on savings and current accounts.

For a bank to be profitable, it needs to charge a higher rate of interest overall on lending than the rate it pays out overall in interest - this profit is the net interest margin.

For the bank, the bigger the difference between interest charged and interest paid, the bigger its net interest margin and the bigger its profit.

Net interest margins for banks and building societies have seen a generally increasing trend in the years since the 2007-8 financial crisis and this has had implications for savers.

How the Funding for Lending Scheme increased net interest margins

In July 2012, the Bank of England introduced the Funding for Lending Scheme(FLS) ^† to encourage banks and building societies to lend more readily.

The scheme essentially made cheap loans available to banks which could, in turn, be lent to customers.

Although the FLS did increase the availability of loans and mortgages, it has had a knock-on effect on net interest margins by greatly reducing interest for savers.

Net interest margins and increasing bank profits

Net interest margins reveal that banks can significantly boost their profits by offering lower interest on savings and charging higher interest on borrowing.

RBS’s annual report for 2014 ^† showed that the bank’s net interest margin on personal and business banking for the year to 31 December was 3.42%, up from 3.21% the previous year.

This seemingly small increase means RBS earned an extra £210m in net interest that year compared with the previous year, taking its net interest income to £5.319bn.

It was a similar story for Barclays, with its 2014 annual report ^† showing that net interest margin on personal banking for the year to 31 December was 3% - up from 2.1% the previous year.

This means Barclays earned an extra £405m in net interest, taking net interest income to £6.298bn.

Building societies’ returns should be directed back to benefitting its members, but Nationwide also showed an increased net interest margin for the year to 4 April, 2015, in its annual report.^†

Its net interest margin was 1.46%, up from 1.25% the previous year, meaning Nationwide took an extra £458m in net interest income compared with the previous year, taking net interest income to £2.86bn.

All these results certainly seem to suggest that the banks and building societies have used the FLS to increase their profits - at the expense of savers.

Net interest margins and lower savings interest

The FLS was bad news for savers.

Because cheap funds were made available to banks, they didn’t need to try so hard to attract savings customers to provide funding, so savings rates dropped dramatically.

At the same time, banks’ net interest margins have seen an increasing upward trend, as evinced by the annual report figures.

Speaking to the BBC’s Money Box programme on 29 November, 2014,^† Savings Champion’s Anna Bowes said of the banks: “They’re boosting profits by paying savers less.”

She noted that there had been 2,500 rate cuts on savings since FLS was introduced in 2012, despite the Bank of England base rate staying the same.

Even though the FLS was changed in 2014 to encourage lending to businesses instead of individuals, at the time of writing (September 2015) interest rates on savings remained low.

Banks have maintained low interest rates in the competitive mortgage market by continuing to pay low rates on savings.

This could remain the case until banks are once again in need of investment from savers, forcing them to offer more competitive rates to attract them.

Net interest margins and your money

Because banks strive to increase their net interest margins, you’ll usually be better off paying off any debts before putting money in savings.

That’s because you’re likely to pay more in interest on loans and mortgages than you can earn in interest.

Because of this, you might want to consider overpaying your mortgage with savings, or even considering an offset account.

However, there are exceptions, so check rates on products like high-interest current accounts before deciding whether you’d be better off repaying or saving.

Bear in mind that government student loans are another notable exception, and you may be better off saving rather than repaying these early.

You might also find it useful to amass some emergency savings in a rainy-day fund as well before paying off debts.

By Derri Dunn