What Is Net Interest Income?

What Is Net Interest Income?

Net interest income, or NII, is a financial performance measure that shows the difference between the revenue you get from interest-bearing assets and the expenses from interest-bearing liabilities. It's what keeps banks, credit unions, and other lenders going, as it determines their revenue generation, credit extension, and resilience in tough economies. I'll focus on banks here, but remember, many financial institutions, sectors, and investors deal with NII too.

In this piece, I'll cover the factors that influence NII, the formulas for calculating it, and real-world examples to help you see how it applies to assessing a bank's profitability.

Understanding Net Interest Income (NII)

A typical bank's assets consist of personal and commercial loans, mortgages, and securities, while liabilities are interest-bearing customer deposits. The excess revenue from interest on assets over interest paid on deposits is your NII.

Some banks' NII is more sensitive to interest rate changes than others. These changes often come from a country's central bank, like the U.S. Federal Reserve, which sets overnight lending rates that banks use to set their own. Sensitivity depends on the types of assets and liabilities, and whether they have fixed or variable rates. If a bank has variable-rate assets and liabilities, it'll feel interest rate shifts more than one with fixed-rate holdings.

Interest-earning assets vary from mortgages to auto, personal, and commercial real estate loans, each with different risks and thus different interest rates. For instance, personal loans usually have higher rates than mortgages.

The NII from a bank's assets hinges on what they hold, and even similar loans can have fixed or variable rates based on the borrower. You see this often with mortgages, where banks offer both fixed- and adjustable-rate options.

Loan portfolio quality also impacts NII. In a weakening economy with high job losses, borrowers might default, leading to lower NII.

Major Sources of Banking Income

I've compiled details on major banking products, whether they count toward NII, their descriptions, and relative risks. For example, accounts receivable financing counts toward NII with moderate risk, as it involves selling receivables for quick cash. Alternative investments like hedge funds generally don't count and carry high risk. Asset financing usually doesn't unless it's financial leases, with low to moderate risk. Brokerage services don't contribute to NII and have low risk. Corporate finance loans do count, with moderate to high risk for business expansions. Credit cards count, offering revolving credit with high risk. Current accounts and deposits count, being low-risk funds in checking or savings. Custody services don't, involving low-risk trade processing. Fixed-rate bonds count, providing low-risk fixed interest. Foreign exchange doesn't, with low to medium risk for currency trades. Insurance doesn't count, low risk. Interbank lending counts, low risk. Investment management doesn't, moderate risk. Leveraged loans count, high risk for indebted firms. Lines of credit count, moderate risk. Mortgages count, moderate risk. Notice deposit accounts count, low risk. Overdrafts count, moderate risk. Packaged accounts count via linked products, low risk. Personal loans count, moderate risk. Project finance counts, high risk. Real estate loans count, moderate risk. Structured finance counts, high risk. Syndicated loans count, moderate risk. Term loans count, moderate risk. Trade finance counts, moderate risk. Trusts and estate planning don't, low risk. Wealth solutions don't, low risk.

Fast Fact

About a quarter of U.S. banks' income before expenses comes from non-interest sources.

How To Calculate Net Interest Income

NII is a basic metric for financial institutions, especially banks, to evaluate lending and borrowing profitability. You calculate it as the difference between revenue from interest-earning assets and expenses from interest-bearing liabilities.

The formula is: Net Interest Income (NII) = Interest Income - Interest Expense. Interest Income is total earnings from assets like loans, bonds, and investments. Interest Expense is total interest paid on deposits, loans, and other debt.

In 2023, FDIC-insured banks and savings institutions reported $698.9 billion in net interest income.

Examples of Net Interest Income

Let's say you manage XYZ Bank with $50 million in loans at 6% average interest and $30 million in government securities at 4%. For expenses, there are $60 million in deposits at 2% and $20 million in borrowings at 3%. Interest income: $3 million from loans plus $1.2 million from securities equals $4.2 million. Interest expense: $1.2 million on deposits plus $0.6 million on borrowings equals $1.8 million. So NII is $2.4 million.

Or take Bank ABC with $1 billion in loans at 5% earning $50 million, and $1.2 billion in deposits at 2% costing $24 million, resulting in $26 million NII.

Big banks like JPMorgan Chase saw NII rise 33.81% in 2023, and Bank of America 8.52%. I've got aggregate NII data for U.S. banks over the last two decades, but the point is clear: NII can fluctuate significantly.

Beyond Net Interest Income

Even if a bank earns more interest from assets than it pays on liabilities, it might not be profitable due to other expenses like rent, utilities, wages, and salaries. Subtract those from NII, and the bottom line could be negative.

Banks also have non-interest revenue, like fees from investment banking or advisory services. When you evaluate a bank's profitability, consider these alongside NII.

What Is Net Interest Margin (NIM)?

NIM measures the difference between interest income from assets like loans and expenses on liabilities like deposits, expressed as a percentage of average earning assets. You calculate it by dividing NII by average earning assets and multiplying by 100. For the U.S. in the late 2010s and early 2020s, NIM ranged from 3.25% to 3.75%, while other major economies saw 1.0% to 2.5%.

What Are Other Important Metrics for Banks?

When you look at a bank's performance, key metrics give insights into its health. NIM shows if the bank earns well on assets versus what it pays on liabilities; higher is better, and compare it to peers. Return on assets (ROA) measures profitability per total assets, indicating efficient use; higher means better conversion to income, and benchmark against the sector.

How Do Interest Rates Impact Consumers?

Interest rates are the cost of borrowing. As they rise, you pay more on mortgages, cars, credit cards, and other loans, especially adjustable-rate ones. Businesses face higher costs for credit-based expenses like machinery, slowing economic activity overall.

The Bottom Line

Net interest income is a vital measure of a bank's core lending and borrowing profitability. You get it by subtracting interest expenses on debts like deposits from interest income on assets like loans. This helps institutions assess their operations and manage funding costs effectively.