What is non-interest income?
Non-interest income is income from banks and creditors primarily from fees, including deposit and transaction fees, insufficient funds charges (NSF), annual fees, monthly service fees, inactivity fees, check and deposit slip fees, etc. Credit card issuers also charge penalty fees, including late fees and fees that exceed the limit. Institutions charge fees that generate non-interest income in order to increase income and provide liquidity in the event of an increase in default rates.
Understanding non-interest income
Interest is the cost of borrowing money and is a form of income that banks collect. For financial institutions, such as banks, interest represents operating income, which is income from normal business activities. The main objective of a bank’s business model is to lend money, its main source of income is therefore interest and its main asset is cash. That said, banks are highly dependent on non-interest income when interest rates are low. When interest rates are high, sources of non-interest income can be reduced to encourage customers to choose one bank over another.
Strategic importance of non-interest income
Most non-bank businesses depend entirely on non-interest income. Financial institutions and banks, on the other hand, get most of their money from loans and loans again. Consequently, these companies consider non-interest income as a strategic element of the income statement. This is especially true when interest rates are low, as banks take advantage of the spread between the cost of funds and the average lending rate. Low interest rates prevent banks from making profits, so they often depend on non-interest income to maintain their profit margins.
From a client’s perspective, sources of income other than interest such as fees and penalties are annoying at best. For some people, these costs can add up quickly and seriously affect the budget. From an investor’s perspective, however, a bank’s ability to compound non-interest income to protect profit margins or even increase margins in good times is positive. The more income a financial institution generates, the better its ability to withstand adverse economic conditions.
Non-interest income factors
The extent to which banks rely on non-interest costs to make a profit depends on the economic environment. Market interest rates are determined by reference rates such as the federal funds rate. The Fed funds rate, or the rate at which banks lend money, is determined by the rate at which the Federal Reserve pays banks’ interest. This rate is called the excess reserve interest rate (IOER). As the IOER increases, banks can benefit more from interest income. At some point, it becomes more beneficial for a bank to use reduced fees and charges as a marketing tool to attract new deposits, rather than as a means of increasing profits. Once a bank has made this decision, the market competition for fees begins again.