What You Need to Know About Noninterest Expenses
A noninterest expense is an operating cost for banks or financial institutions that falls outside the realm of interest expenses and provisions for credit losses. Common examples of noninterest expenses include:
- Employee salaries, bonuses, and benefits
- Equipment rental or leasing
- Information technology (IT) costs
- Rent, telecommunication services, taxes, professional services, and marketing
- Amortization of intangibles
Key Insights
- Noninterest expenses encapsulate the fixed operating costs of a bank, including items like salaries and rent.
- These costs are offset by service fees, such as fee income from loan origins, late payment charges, annual fees, and credit facility fees.
- Noninterest expenses tend to be higher for investment banks than for commercial banks due to the costly nature of trading, asset management, and capital market advisory services.
Decoding Noninterest Expenses
Banks have two primary types of expenses: interest and noninterest. Interest expenses are associated with deposits, loans, and trading account liabilities. In contrast, noninterest expenses cover various operational costs required for a bank’s day-to-day functions. These are not directly tied to depositor funds or loans.
The Main Components of Noninterest Expenses
Effective management of noninterest expenses is essential for maximizing bank profits. Excessive noninterest expenses negatively impact profitability. Understanding the main components:
- Personnel Costs: Predominantly, employee salaries and benefits constitute the major portion.
- Occupancy and IT Costs: These include cost factors associated with operating physical and digital workspaces.
- Professional Fees: These costs usually cover legal services and other consultants.
Noninterest expenses represent a bank’s overhead, used to evaluate the overhead ratio. The overhead ratio is the result of dividing noninterest expense by average assets. If this ratio climbs to unacceptable levels, strategic measures are often taken, beginning with personnel costs due to their significant portion of noninterest expenses.
Noninterest Expenses by Bank Type
While noninterest expenses usually run high among investment banks compared to commercial banks, this can vary based on employee count and compensation. Trade-oriented banks like investment firms have higher wages for fewer employees, whereas commercial banks necessitate a greater number of lower-cost employees.
In 2021, for instance, Wells Fargo had around 247,000 employees, whereas Morgan Stanley had approximately 60,000. For Morgan Stanley, noninterest expenses were 66% of revenues, with compensation alone constituting about 38%. Conversely, Wells Fargo reported noninterest expenses and employee costs accounting for 69% and 45% of revenues, respectively.
The Predominance of Personnel Costs
Personnel costs are typically the largest noninterest expense for most banks. To illustrate, Wells Fargo’s personnel expenses in 2021 stood at about 45% of its revenues, translating to $35.5 billion of noninterest expenses out of $78.5 billion in revenues.
Decoding Noninterest Income
Distinct from noninterest expenses, noninterest income denotes income derived from non-interest-generating sources—such as fees, commissions, and investment gains. For example, if a loan includes a $500 origination fee and $100 in service charges, its noninterest income tallies to $600, excluding interest income from the loan.
The Essential Takeaway
Noninterest expenses are bank operating costs unrelated to interest obligations owed to customers or other banks. These expenses cover purchasing equipment, contractual professional services, personnel remunerations, and marketing efforts. The delineation between interest and noninterest expenses is vital for transparency and helps stakeholders understand bank spendings better, aiding in more effective financial management to bolster profits.
Related Terms: interest expense, overhead ratio, noninterest income, personnel costs, bank profitability
References
- Wells Fargo. “About Us”.
- Morgan Stanley. “About Us”.
- Morgan Stanley. “Morgan Stanley Fourth Quarter and Full Year 2021 Earnings Results”, Pages 10-11.
- Wells Fargo. “2021 Annual Report”, Pages 5 and 12.
