Net Interest Rate Spread

FX Street  Jul 11  Comment 
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Net Interest Rate Spread refers to the difference between a company's cost of borrowing and the interest rate it can earn on its money. For example, if a company is able to borrow at 2% interest and is able to earn 3% interest, its interest rate spread is the difference between the two: 1%, or 100 basis points. Interest rate spread is similar to Net Interest Margin, but is different in that Net Interest Rate Spread is a hypothetical number that a company could earn if all assets were borrowed and invested at the going rates. In reality, some assets are, for example, kept in non-interest bearing accounts and therefore may incurr borrowing costs without earning any interest. Net Interest Margin takes this into account and is the percentage return the company actually achieved in the real world.

Companies are able to earn higher interest rates than they pay for a variety of reasons - a common strategy is to take advantage of differences between long-term interest rates and short-term interest rates, a difference often called the yield curve. Long-term interest rates are typically higher than short term rates to compensate for the innaccessability of money lent out for long periods of time - you can't get your money back until the term of the loan is complete.

Many financial services companies borrow money at short-term rates (for example, paying low savings-account interest rates to their depositors), and lend at long-term rates (for example, through mortgages). When the interest rate spread is large, this can be a source of significant profit for banks, since they collect interest at high rates but only pay low short-term rates. As the spread shrinks (or even becomes negative), this source of profit disappears.

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