Chapter 2 · Part 2 — Statement of Profit or Loss

The profit waterfall, and net interest income

How a bank's P&L is built, the effective interest rate, Nepal's EIR transition, and why interest stops accruing on bad loans.

7 of 51 · 15 min

24 terms. The P&L of a bank is a waterfall, not a list. Each subtotal is deliberately placed so a reader can see where money is made and where it is lost. Learn the waterfall and the individual terms become obvious.

Part 2 checklist

Interest income · Interest expense · Net interest income · Fees and Commission Income · Fees and commission expense · Net fee and commission income · Net interest, fee and commission income · Net trading income · Other operating income · Total operating income · Impairment charge/(reversal) for loans and other losses · Net operating income · Operating expense · Personnel expenses · Other operating expenses · Depreciation & Amortisation · Operating Profit · Non operating income · Non operating expense · Profit before income tax · Income tax expense · Current Tax · Deferred Tax expense/(Income) · Profit for the period

The profit waterfall

┌──────────────────────────────────────────────────────────────────────┐
│                      INTEREST INCOME                                 │
│            (what borrowers and securities pay the bank)              │
└────────────────────────────────┬─────────────────────────────────────┘
                                 │  LESS
┌────────────────────────────────▼─────────────────────────────────────┐
│                     INTEREST EXPENSE                                 │
│              (what the bank pays depositors and lenders)             │
└────────────────────────────────┬─────────────────────────────────────┘
                                 ▼
╔══════════════════════════════════════════════════════════════════════╗
║              NET INTEREST INCOME  (NII)  ← the core of banking       ║
╚════════════════════════════════┬═════════════════════════════════════╝
                                 │  PLUS
┌────────────────────────────────▼─────────────────────────────────────┐
│   Fees & commission income  −  Fees & commission expense             │
│              = NET FEE AND COMMISSION INCOME                         │
└────────────────────────────────┬─────────────────────────────────────┘
                                 ▼
╔══════════════════════════════════════════════════════════════════════╗
║          NET INTEREST, FEE AND COMMISSION INCOME                     ║
╚════════════════════════════════┬═════════════════════════════════════╝
                                 │  PLUS
┌────────────────────────────────▼─────────────────────────────────────┐
│   Net trading income      (FX and securities dealing)                │
│   Other operating income  (dividends, rent, recoveries, revaluation) │
└────────────────────────────────┬─────────────────────────────────────┘
                                 ▼
╔══════════════════════════════════════════════════════════════════════╗
║                   TOTAL OPERATING INCOME                             ║
╚════════════════════════════════┬═════════════════════════════════════╝
                                 │  LESS
┌────────────────────────────────▼─────────────────────────────────────┐
│   IMPAIRMENT CHARGE / (REVERSAL) for loans and other losses          │
│   ← the cost of credit risk. THE swing factor in a Nepali bank.      │
└────────────────────────────────┬─────────────────────────────────────┘
                                 ▼
╔══════════════════════════════════════════════════════════════════════╗
║                    NET OPERATING INCOME                              ║
╚════════════════════════════════┬═════════════════════════════════════╝
                                 │  LESS  OPERATING EXPENSE
┌────────────────────────────────▼─────────────────────────────────────┐
│   Personnel expenses                                                 │
│   Other operating expenses                                           │
│   Depreciation & Amortisation                                        │
└────────────────────────────────┬─────────────────────────────────────┘
                                 ▼
╔══════════════════════════════════════════════════════════════════════╗
║                      OPERATING PROFIT                                ║
╚════════════════════════════════┬═════════════════════════════════════╝
                                 │  ± NON-OPERATING ITEMS
┌────────────────────────────────▼─────────────────────────────────────┐
│   + Non operating income        − Non operating expense              │
└────────────────────────────────┬─────────────────────────────────────┘
                                 ▼
╔══════════════════════════════════════════════════════════════════════╗
║                   PROFIT BEFORE INCOME TAX                           ║
╚════════════════════════════════┬═════════════════════════════════════╝
                                 │  LESS INCOME TAX EXPENSE
┌────────────────────────────────▼─────────────────────────────────────┐
│   Current Tax  +  Deferred Tax expense/(Income)                      │
└────────────────────────────────┬─────────────────────────────────────┘
                                 ▼
╔══════════════════════════════════════════════════════════════════════╗
║               PROFIT FOR THE PERIOD                                  ║
║          → flows to Retained Earnings (Part 5)                       ║
║          → basis of EPS, ROE, ROA (Part 6)                           ║
║          → starting point of Distributable Profit (Part 7)           ║
╚══════════════════════════════════════════════════════════════════════╝

The three sources of a bank's income

Every rupee a bank earns comes from one of three engines. Understanding the mix is the first thing an analyst does:

Engine	Line	Nature	Volatility
1. Lending spread	Net interest income	Balance-sheet driven, recurring	Low — but rate-sensitive
2. Services	Net fee and commission income	Transaction driven, capital-light	Low–medium
3. Markets	Net trading income	Price driven	High

A bank whose profit growth comes from engine 1 and 2 is building something durable. A bank whose growth comes from engine 3 is riding markets.

Read the source report's mix. (NMB, Bank standalone, YTD Asar 2083, NPR thousand.)

Net interest income                 9,426,240   =  72.4% of total operating income
Net fee and commission income       2,590,868   =  19.9%
Net trading income                    681,415   =   5.2%
Other operating income                325,545   =   2.5%
                                   ──────────
Total operating income             13,024,067      100.0%

Nearly three-quarters from lending spread — the classic profile of a commercial bank in a market without deep capital markets. This makes NMB's earnings highly sensitive to interest rates and to credit quality, and relatively insensitive to market volatility.

Interest income

Simple definition. Everything the bank earns from lending money and from holding interest-bearing securities.

Technical definition. Income recognised on an accrual basis over the life of interest-bearing financial assets using the effective interest method, being the rate that exactly discounts estimated future cash receipts through the expected life of the financial asset to its gross carrying amount.

Sources in a Nepali bank.

Interest on loans and advances to customers (dominant)
Interest on loans and advances to BFIs
Interest and discount accretion on government treasury bills and development bonds
Interest on placements with BFIs
Interest on nostro and NRB balances
Interest on staff loans (see the Day 1 difference discussion, Part 1.16)

Framework. NFRS 9 for measurement; NRB Interest Income Recognition Guidelines (with amendments) for the Nepal-specific recognition rules; NFRS 15 does not apply to interest.

The effective interest rate — and Nepal's transition

Formula.

                         CF₁          CF₂                CFₙ
Gross carrying    =   ────────  +  ────────  +  …  +  ────────
   amount            (1 + EIR)¹   (1 + EIR)²          (1 + EIR)ⁿ

Solve for EIR — the internal rate of return of the instrument's cash flows.

Component explanation.

CFₙ — all contractual cash receipts: principal, interest, and fees integral to the yield (loan documentation fee, loan management fee, arrangement fee)
Gross carrying amount — the amount disbursed plus directly attributable transaction costs
EIR — the single rate that reconciles them. It is not the coupon rate.

Why EIR differs from the nominal rate. If a bank lends NPR 10,000,000 at a stated 10% but charges a 1% documentation fee up front, the borrower effectively receives NPR 9,900,000 and repays as if on 10,000,000. The true yield is above 10%. EIR captures that; the coupon rate does not.

The Nepal-specific transition — read this carefully. The source report states: "From FY 2083/84, EIR shall be applicable for all financial assets except old term loan (Old term loan refers to loans booked up to Asar end 2083). Therefore, as per Interest Income Recognition Guidelines (With Amendment) has been followed and income has been recognized based on Gross Interest Rate."

LOANS BOOKED UP TO ASAR END 2083     LOANS BOOKED FROM FY 2083/84
────────────────────────────────     ────────────────────────────
"Old term loans"                     New lending
Income on GROSS INTEREST RATE        Income on EFFECTIVE INTEREST RATE
(fees recognised separately)         (integral fees spread into yield)

Two populations, two methods, running side by side for years. Consequence for analysts: as the old book runs off and the new book grows, reported interest income and fee income will shift between each other for methodological reasons, not commercial ones. Do not read that shift as a change in pricing power.

Interest recognition by ECL stage — the NRB rule

Stage	Basis	Recognised on
Stage 1	Accrual	Gross carrying amount
Stage 2	Accrual	Gross carrying amount
Stage 3	Cash basis (incremental)	Only what is actually received

The report confirms: "interest income based on coupon interest rate on principal outstanding for all financial assets (accrual basis) for Stage 1 and 2 and based on cash basis approach (incremental) for FY 82/83."

Journal-entry logic.

Accrual on a performing (Stage 1) loan:
Dr  Interest receivable / Loans and advances    916,667
    Cr  Interest income                                    916,667

Cash received:
Dr  Cash and cash equivalent                    916,667
    Cr  Interest receivable                                916,667

Loan moves to Stage 3 — accrual stops.
Interest is recognised ONLY on receipt:
Dr  Cash                                        400,000
    Cr  Interest income                                    400,000

Worked example. Illustrative — HCBL.

Loan portfolio (average)                NPR 200,000,000,000
Average yield                                        11.5%
Investment securities (average)         NPR  40,000,000,000
Average yield                                         6.0%

Interest income from loans     = 200bn × 11.5%  = NPR 23,000,000,000
Interest income from securities=  40bn ×  6.0%  = NPR  2,400,000,000
                                                  ─────────────────
Total interest income                             NPR 25,400,000,000

Presentation. First line of the P&L. Notes disaggregate by source.

*(NMB, Asar 2083, Bank YTD: NPR 21,041,592 thousand against NPR 22,267,952 thousand a year earlier — interest income FELL 5.5% despite the loan book growing ~10%. That divergence is the single most important observation in this P&L. It implies a sharp fall in lending rates, and/or a growing Stage 3 book on which accrual has stopped. Both are consistent with the reported NPL rise from 4.11% to 4.91% and with base rate falling from 6.22% to 5.11%.)*

Effect on cash flow. Interest received is a separate line under operating activities in the direct method — and it will differ from interest income because of accruals. In the source report: interest income NPR 21,041,592 thousand vs interest received NPR 18,855,966 thousand (Bank). The NPR 2.19bn gap is accrued-but-uncollected interest — a genuine quality-of-earnings signal. See Part 4.

Effect on regulatory ratios. Drives Base Rate, Average Interest Spread, ROA and ROE. NRB's regulatory reserve mechanism specifically appropriates accrued interest receivable out of distributable profit (see Part 7) — precisely because interest recognised but not collected is not spendable.

Analyst interpretation.

Compare interest income growth to loan growth. Income growing slower means falling yields or rising non-accrual.
Compare interest income to interest received (cash flow statement). A widening gap is a warning.
In a falling-rate environment, interest income falls before interest expense does, because loans reprice faster than fixed deposits. Expect margin compression on the way down and expansion on the way up.

Related terms. Interest expense · Net interest income · Part 1.7 Loans and advances to customers · Part 4 Interest received · Part 6 Base Rate, Average Interest Spread · Part 7 Interest receivable · Part 8 EIR, Revenue recognition, Stage 1/2/3

Interest expense

Simple definition. What the bank pays to depositors and lenders for the use of their money.

Technical definition. The cost of interest-bearing financial liabilities recognised on an accrual basis using the effective interest method, comprising interest on deposits, interbank borrowings, debentures, subordinated liabilities and other borrowings.

Components in a Nepali bank.

Source	Relative cost
Savings deposits	Low [R] (NRB has set minimum savings rates at times)
Fixed / term deposits	High — the main driver
Call deposits	Moderate, rate-sensitive
Current accounts	~Zero
Interbank borrowing	Market-driven, spikes in tight liquidity
Debentures	High, fixed, long
DFI borrowing	Often lower, but FX risk
Lease liabilities (NFRS 16)	Unwinding of discount

Journal entry.

Dr  Interest expense                     66,667
    Cr  Deposits from customers / Interest payable   66,667

On payment (net of TDS [R]):
Dr  Deposits from customers / Interest payable  66,667
    Cr  Cash                                            60,000
    Cr  TDS payable to IRD                               6,667

Worked example. Illustrative — HCBL, showing why deposit mix dominates.

                       Balance (NPR)      Rate      Interest expense
Current accounts       30,000,000,000     0.0%                    0
Savings deposits       90,000,000,000     4.0%      3,600,000,000
Call deposits          20,000,000,000     5.5%      1,100,000,000
Fixed deposits        110,000,000,000     8.5%      9,350,000,000
                     ───────────────                ─────────────
Total deposits        250,000,000,000              14,050,000,000

Cost of deposits = 14,050,000,000 ÷ 250,000,000,000 = 5.62%
CASA ratio = (30bn + 90bn) ÷ 250bn = 48.0%

NOW shift NPR 20bn from savings into fixed deposits:
Savings   70bn × 4.0% =  2,800,000,000
Fixed    130bn × 8.5% = 11,050,000,000
New total interest expense = 14,950,000,000
New cost of deposits = 5.98%   (+36 basis points)
CASA falls to 40.0%

→ The SAME deposit total costs NPR 900 million more,
  purely because of mix. This is why banks fight for CASA.

Presentation. Second line of the P&L, deducted from interest income.

*(NMB, Asar 2083, Bank YTD: NPR 11,615,353 thousand vs NPR 14,247,058 thousand — an 18.5% fall. Interest expense fell far faster than interest income (−5.5%), which is why net interest income rose 17.5% despite falling revenue. This is a falling-rate environment working in the bank's favour: deposits repriced down faster and further than loans.)*

Effect on cash flow. Interest paid under operating activities — again differing from the accrual figure. (Bank: expense NPR 11,615,353 thousand vs paid NPR 11,637,580 thousand — very close, indicating the bank settles deposit interest promptly.)

Effect on regulatory ratios. Directly drives Cost of Funds, Base Rate and Average Interest Spread (Part 6). NRB has at times capped the spread between deposit and lending rates [R].

Analyst interpretation. The relationship between interest income and interest expense tells you the rate cycle:

RATES FALLING                        RATES RISING
─────────────                        ────────────
Loans reprice down quickly           Loans reprice up quickly
Fixed deposits reprice down only     Fixed deposits reprice up only
on maturity (with a lag)             on maturity (with a lag)
     ↓                                    ↓
Interest expense falls FASTER        Interest income rises FASTER
     ↓                                    ↓
MARGIN EXPANDS (temporarily)         MARGIN EXPANDS (temporarily)
     ↓                                    ↓
Then loans reprice fully →           Then deposits reprice fully →
margin normalises                    margin compresses

NMB's FY2082/83 is a textbook falling-rate margin expansion. The important analytical question is whether it is sustainable — it usually is not, once the deposit book has fully repriced.

Related terms. Interest income · Net interest income · Part 1.21 Deposits from customers · Part 4 Interest paid · Part 6 Cost of Funds, Base Rate, Average Interest Spread

Net interest income

Simple definition. The bank's core earnings — what it charges borrowers minus what it pays depositors.

Technical definition. Interest income less interest expense, representing the net return on interest-bearing assets funded by interest-bearing liabilities.

Formula.

Net Interest Income (NII)  =  Interest Income  −  Interest Expense

Related margin measures.

                                  Net Interest Income
Net Interest Margin (NIM)  =  ─────────────────────────────  × 100
                              Average interest-earning assets

                          Interest Income        Interest Expense
Interest Spread  =    ───────────────────  −  ────────────────────────
                      Average earning assets   Average interest-bearing
                                                     liabilities

Component explanation.

Interest-earning assets — loans, investments, placements, NRB and bank balances. It

excludes PPE, goodwill, deferred tax and other non-earning assets.

NIM vs spread — spread compares two rates. NIM measures the return on the *asset base*, so it also captures the benefit of funding some assets with free money (current accounts and equity). NIM is normally higher than spread, and the gap is the value of zero-cost funding.

Worked example. Illustrative — HCBL.

Interest income                    NPR 25,400,000,000
Interest expense                   NPR 14,050,000,000
                                   ──────────────────
Net interest income                NPR 11,350,000,000

Average interest-earning assets    NPR 240,000,000,000

NIM = 11,350,000,000 ÷ 240,000,000,000 × 100  =  4.73%

The actual NMB numbers, worked. (Bank standalone, YTD, NPR thousand.)

                          FY2082/83      FY2081/82      Change
Interest income            21,041,592     22,267,952     −5.51%
Interest expense           11,615,353     14,247,058    −18.47%
                          ──────────     ──────────
Net interest income         9,426,240      8,020,894    +17.52%

NII as % of total operating income = 9,426,240 ÷ 13,024,067 = 72.4%

Analyst interpretation of that result.

NII up 17.5% while revenue fell — growth came entirely from the funding side.
This is not repeatable. Once deposits have fully repriced to the lower rate environment, the tailwind stops. If lending rates keep falling, NII will compress.
Cross-check with Part 6: Cost of Funds fell from 5.10% to 3.78% (Group) — a 132 basis point drop — while Base Rate fell from 6.22% to 5.11%, only 111bp. The bank's funding cost fell more than its lending benchmark. That gap is the margin expansion, quantified.

Effect on everything downstream. NII is 72% of operating income here, so it drives operating profit, PAT, EPS, ROE and ROA. A 10% move in NII moves PAT far more than 10% because operating costs are largely fixed — operating leverage.

Illustrating operating leverage. Illustrative.

                        Base case      NII +10%      NII −10%
Net interest income      9,426          10,369         8,484
Other income             3,598           3,598         3,598
                        ──────          ──────        ──────
Total operating income  13,024          13,967        12,082
Impairment              (2,345)         (2,345)       (2,345)
Operating expenses      (4,561)         (4,561)       (4,561)
                        ──────          ──────        ──────
Operating profit         6,118           7,061         5,176
Change                       —          +15.4%        −15.4%

→ A 10% move in NII produces a 15.4% move in operating profit.

Related terms. Interest income · Interest expense · Part 6 Cost of Funds, Base Rate, Average Interest Spread · Part 17

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