Net interest income represents the difference between the revenue generated from a bank’s interest-bearing assets and the expenses tied to its interest-bearing liabilities. A bank’s assets may include various loans such as personal, commercial, mortgages, and securities. On the liability side, we find interest-bearing customer deposits. The net revenue derived from this setup is the net interest income.
Key Insights
- Net interest income indicates the difference between the income from a bank’s interest-bearing assets and the cost associated with its interest-bearing liabilities.
- These assets usually include mortgages, auto loans, personal loans, and commercial real estate loans.
- The quality of the loan portfolio, interest rates, and the type of loans (fixed or variable) significantly influence the net interest income.
- Banks determine their net interest income by deducting the interest payable to clients from the interest income earned.
- Banks’ quarterly and annual reports list net interest income.
How Interest Rates Influence Net Interest Income
The sensitivity of a bank’s net interest income to fluctuating interest rates depends on the nature of its assets and liabilities, as well as whether their rates are fixed or variable. A bank with variable-rate assets and liabilities will exhibit greater sensitivity to rate changes compared to one with fixed-rate holdings.
The types of loans generating interest for the bank can include mortgages, auto loans, and commercial real estate loans. These loans usually carry diverse risks, influencing their interest rates; for instance, personal loans typically carry higher rates than mortgages.
The ultimate net interest income results also depend on the structure of the bank’s asset holdings as loans can be either fixed or variable-rate. A deteriorating economy and substantial job losses may cause more borrowers to default, affecting the bank’s net interest income negatively.
Example of Net Interest Income in Action
Consider a bank with a $1 billion loan portfolio earning an average of 5% interest, equating to $50 million in interest revenue. If this bank has customer deposits totaling $1.2 billion earning 2% interest, it incurs an interest expense of $24 million. Therefore, net interest income stems at $26 million ($50 million - $24 million).
To provide comparisons:
- Both JPMorgan Chase and Bank of America witnessed noticeable reductions in their net interest income between 2020 and 2021, elucidating the diversity in how even the largest banks experience fluctuations.
$180 billion
Q4 2022 marked the net interest income for FDIC-insured banks and saving institutions.
Extra Factors to Consider
Net interest income alone does not dictate profitability. Banks need to cover other costs such as rent, salaries, utilities, and management expenses from this income. Therefore, it is essential to consider these factors and any additional revenue sources like investment advisory fees when assessing a bank’s profitability.
FAQ
What Does Net Interest Income Mean?
Net interest income is the difference between the earnings generated from interest-bearing assets and the expenditures on interest-bearing liabilities.
How Do You Calculate Net Interest Income?
Calculate by subtracting the cost of interest-bearing liabilities from the income generated by interest-bearing assets.
What Is NII and NIM?
Net Interest Income (NII) is the income realized from lending activities minus the interest paid to depositors, while Net Interest Margin (NIM) is calculated by dividing NII by the average earning assets.
What Is Net Interest Income for Banks?
It’s a financial metric assessing the income product from interest-bearing assets against the expenses of interest-bearing liabilities, illustrating financial health and profitability potential.
Related Terms: Net Interest Margin, Interest Rate, Loan Portfolio, Financial Profitability.
References
- Bank of America. “Annual Report 2021”, Page 67.
- JPMorgan Chase. “Annual Report 2021”, Page 76.
- Federal Reserve Bank of St. Louis. “Income and Expense: Net Interest Income”.
