What is net interest income?
Net interest income is a measure of financial performance that reflects the difference between the income generated by a bank’s interest-bearing assets and the expenses associated with paying its interest-bearing liabilities. The assets of a typical bank consist of all forms of personal and commercial loans, mortgages and securities. Liabilities are deposits from customers bearing interest. The excess income generated by interest earned on assets over interest paid on deposits is net interest income.
Understanding net interest income
The net interest income of some banks is more sensitive to changes in interest rates than others. This can vary depending on several factors, such as the type of assets and liabilities held as well as whether these assets and liabilities have fixed or variable rates. Banks with variable rate assets and liabilities will be more sensitive to changes in interest rates than banks with fixed rate assets and liabilities.
The type of assets remunerated for the bank can vary considerably, from mortgage loans to car loans, personal loans and commercial real estate loans. This will ultimately affect the rate of interest a bank earns on its assets and the resulting net interest income after subtracting interest paid to depositors. In addition, loans of the same type can carry fixed rates or variable rates. This is most often seen with mortgages, as banks offer fixed rate and variable rate mortgages.
The quality of the loan portfolio is also a factor affecting net interest income, as circumstances such as a slowing economy and job losses can cause borrowers to default on their loans and, as a result, , reduce the bank’s net interest income.
Example of net interest income
If a bank has a $ 1 billion loan portfolio that earns an average of 5% interest, the bank’s interest income will be $ 50 million. On the liability side, if the bank has outstanding customer deposits of $ 1.2 billion generating 2% interest, its interest expense will be $ 24 million. The bank will generate $ 26 million in net interest income ($ 50 million in interest income minus $ 24 million in interest expense).
A bank can earn more interest on its assets than it pays on its liabilities, but that doesn’t necessarily mean it is profitable. Banks, like other businesses, have additional expenses such as rent, utilities, employee salaries and executive salaries. After subtracting these expenses from net interest income, the net result could be negative. However, banks may also have additional sources of income in addition to interest received on loans, such as investment banking commissions or investment advisory services. Investors should take into account sources of income and incidental expenses in addition to net interest income when assessing a bank’s profitability.