05/27/2011 05:27 pm ET Updated Jul 27, 2011

Money Market Rates Suffer From a Squeeze in Net Interest Margin

"Net interest margin" is a phrase that probably doesn't mean much to you, but right now it is costing you dearly if you have a money market account.

You see, net interest margin is a bank accounting measure that indicates how much money banks are able to earn on your deposits. The more banks earn, the more they are inclined to pay their customers in CDs, savings, and money market accounts. Unfortunately, recent financial reports indicate that net interest margin is being squeezed.

Understanding net interest margin
Bank accounting is complicated -- among other things, money taken out of a bank in the form of a loan is considered an "asset" while money deposited into the bank is considered a "liability." Because of the complexity of bank accounting, there is no one measure that is considered a definitive indicator of bank health and profitability. Instead, bank executives, investment analysts, and regulators look at several different metrics, and one of these is net interest margin.

A relatively straightforward form of bank activity is taking money from one customer (a depositor) and lending it to another (a borrower). In order for banks to make money from this kind of activity, the interest rate they receive from borrowers has to exceed the interest rate they pay to customers. The difference between those two interest rates is the net interest margin.

Naturally, net interest margin has to be wide enough to cover the overhead involved in both taking care of deposits and making loans, with enough left over to represent a worthwhile profit for the bank. Recent financial reports from two banks illustrate some of the problems banks have had maintaining a healthy net interest margin in the current environment.

US Bancorp and Comerica both showed signs of a similar problem recently -- they had attracted too much money! Again, bank accounting is complicated. In this case, attracting too much money meant that an influx of new deposits could not be put to productive use, so the net interest margins of these banks suffered.

The impact on money market rates
While the problems of US Bancorp and Comerica are specific to those two banks, they are reasonably indicative of banking conditions these days. Deposits are easy to come by, while loan activity is slack.

You don't have to understand the intricacies of bank accounting to realize that if deposits are easy to come by, banks are not going to be particularly motivated to pay high interest rates on money market accounts and other deposits in order to attract more. Indeed, because net interest margin is a closely-watched figure, some banks may make a conscious decision to offer uncompetitive money market rates so as not to attract deposits.

This is one of the ironies of the economy right now -- the recovery is far from robust, and yet there seems to be too much money available. It's not that there aren't plenty of people who could use that money, but qualified borrowers are all too scarce in this environment.

The condition of too many deposits helps explain why money market rates have continued to decline even while inflation and mortgage rates have increased in recent months. When will money market rates turn around? Keep your eyes on net interest margin for a possible clue.

The original article can be found at
"Money market rates suffer from a squeeze in net interest margin"