Net interest income (NII) is a financial performance measure that reflects the difference between the revenue generated from interest-bearing assets and the expenses associated with paying on its interest-bearing liabilities. It’s the lifeblood that sustains banks, credit unions, and other lenders, determining their ability to generate revenue, extend credit, and weather economic storms. In this article, we’ll discuss banks, but many financial institutions, entire economic sectors, and investors can have NII.
Below, we review the factors that shape NII, the formulas used to calculate it, and real-world examples that illustrate how to put this metric into action when reviewing a bank’s profitability.
Key Takeaways
- Net interest income (NII) reflects the difference between the revenue generated from a bank’s interest-bearing assets and the expenses associated with paying its interest-bearing liabilities.
- Interest-earning assets can range from mortgages to auto, personal, and commercial real estate loans.
- The amount of NII a bank generates will depend on many factors, including the quality of the loan portfolio, the collective interest rates each type of loan carries, the loans having a fixed or variable rate, and the interest rate environment of the economy.
- Banks calculate their net interest income by subtracting the interest they must pay their clients from the revenue they generate.
- You can find an institution’s NII in its quarterly and annual reports.
Understanding Net Interest Income (NII)
A typical bank’s assets include all personal and commercial loans, mortgages, and securities. The liabilities are interest-bearing customer deposits. The excess revenue generated from the interest earned on assets over the interest paid on deposits is NII.
The NII of some banks is more sensitive to changes in interest rates than others. The main changes derive from a country’s central bank (e.g., the U.S. Federal Reserve), which sets its own overnight lending rates and bank use to determine the rates they offer. These changes can result from the type of assets and liabilities that are held, as well as whether the 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 those with fixed-rate holdings.
Interest-earning assets can range from mortgages to auto, personal, and commercial real estate loans. These loans all typically carry different levels of risk, thus the interest rate the bank earns for each type of loan will vary. For example, a personal loan will almost always carry a higher interest rate than a mortgage. Below is a table of the major sources of income for a bank, whether they count toward NII, and their relative risk:
| Banking Income Sources | |||
|---|---|---|---|
| Banking Product | Counts Toward NII? | Description | Relative Risk |
| Accounts Receivable Financing | Yes | Transactions are when a firm sells its accounts receivable to a third party to get cash more quickly than when waiting for customers to pay. | Moderate |
| Alternative Investments (e.g., Hedge Funds) | Not generally | Investments aside from stocks, bonds, or cash. | High |
| Asset Financing | No (unless financial, not operating leases) | Leases of equipment for use. | Low-Moderate |
| Brokerage | No | Buy and sell orders for financial assets in exchange for a fee or commission. | Low |
| Corporate Finance | Yes | Loans to businesses for mergers, acquisitions, and other forms of expansion or restructuring. | Moderate-High |
| Credit Cards | Yes | Revolving credit lines for purchases with interest charged on balances. | High |
| Current Accounts/ Deposits | Yes | Funds held in checking, savings, money market, and CD accounts can be withdrawn with little notice. | Low |
| Custody Services | No | Processing trades in securities and keeping financial assets secured for other parties | Low |
| Fixed-Rate Bonds | Yes | Fixed-term accounts offering a fixed rate of interest over a specific period. | Low |
| Foreign Exchange | No | Facilitates clients needing to trade in foreign currencies and remit funds internationally. | Low-Medium |
| Insurance | No | Products through which a company compensates for loss/damage, illness/death, in return for premium payment. | Low |
| Interbank Lending | Yes | Loans between banks. | Low |
| Investment Management | No | Professional management of securities and assets to meet investment goals. | Moderate |
| Leveraged Loans | Yes | Floating rate loans to heavily indebted corporations secured by specific assets. | High |
| Lines of Credit | Yes | Flexible borrowing arrangements with interest on funds used. | Moderate |
| Mortgages | Yes | Loans secured by property. | Moderate |
| Notice Deposit Accounts | Yes | Savings account requiring notice before withdrawal to avoid penalties. | Low |
| Overdrafts | Yes | Short-term borrowing when an account balance goes below zero. | Moderate |
| Packaged Accounts | Yes (when through linked products) | Current accounts with extra features like insurance and better rates. | Low |
| Personal Loans | Yes | Unsecured loans from a bank or lender. | Moderate |
| Project Finance | Yes | Funding where repayment comes primarily from project revenues. | High |
| Real Estate Loans (Commercial) | Yes | Loans for commercial properties. | Moderate |
| Structured Finance | Yes | Complex financial instruments for large institutions with needs that can’t be met with more traditional lending. | High |
| Syndicated Loans | Yes | Loans offered by a group of lenders to a single borrower. | Moderate |
| Term Loans | Yes | Loans with a specific repayment schedule and fixed/floating interest rate. | Moderate |
| Trade Finance | Yes | Financing of international trade flows. | Moderate |
| Trusts and Estate Planning | No | A trust holds assets on behalf of a beneficiary; estate planning minimizes taxes on an estate. | Low |
| Wealth Solutions/Financial Planning | No | Advice service for high net worth individuals. | Low |
The resulting NII from a bank’s assets depends on their holdings. Moreover, loans of the same type can carry fixed or variable rates, depending on the consumer. This is frequently seen with mortgages, as most banks offer fixed- and adjustable-rate mortgages.
The quality of the loan portfolio is another factor affecting net interest income. A deteriorating economy and heavy job losses can cause borrowers to default on their loans, resulting in a lower net interest income.
About a quarter of U.S. banks’ income (before expenses) isn’t from interest income.
How To Calculate Net Interest Income
NII is a fundamental metric used by financial institutions, particularly banks, to assess the profitability of their lending and borrowing activities. It’s calculated as the difference between the revenue generated from interest-earning assets and the expenses associated with paying on interest-bearing liabilities.
NetInterestIncome(NII)=InterestIncome−InterestExpense
- Interest Income: Total income earned from assets such as loans, bonds, and other investments
- Interest Expense: Total interest paid on borrowed funds such as deposits, loans, and other forms of debt.
- Income from loans: $50,000,000 × 6% = $3,000,000
- Income from government securities: $30,000,000 × 4% = $1,200,000
- Total Interest Income: $3,000,000 + $1,200,000 = $4,200,000
- Expenses on customer deposits: $60,000,000 × 2% = $1,200,000
- Expenses on borrowings from other banks: $20,000,000 × 3% = $600,000
- Total interest expenses: $1,200,000 + $600,000 = $1,800,000
- NII: $4,200,000 – $1,800,000 = $2,400,000
- NIM: A higher NIM indicates that the bank is earning a higher return on its interest-earning assets compared with what it pays on its interest-bearing liabilities. This suggests there’s been good management of the bank’s lending and borrowing activities. You should also compare with the bank’s NIM to similarly sized banks and other peers.
- Return on assets (ROA): This measures a bank’s profitability relative to its total assets. It indicates how efficiently the bank’s management is using its assets to generate earnings. A higher ROA means the bank is better at converting its assets into net income. As with NIM, comparing a bank’s ROA to sector benchmarks gives you greater clarity of the bank’s performance.
$698.9 billion
2023 net interest income of Federal Deposit Insurance Corporation-insured banks and savings institutions.
Examples of Net Interest Income
Suppose you manage XYZ Bank. This bank has loans to customers worth $50 million at an average interest rate of 6% a year. In addition, XYZ Bank has a $30 million investment in government securities at an average interest rate of 4% a year.
For XYZ’s interest expense, the bank has $60 million in customer deposits at an average rate of 2% a year. Furthermore, the bank has $20 million in borrowing from other banks at an average interest rate of 3% a year.
The total interest income is as follows:
Next, the total interest expense needs to be determined:
Thus the NII for XYZ Bank would be as follows:
Alternatively, suppose Bank ABC has a loan portfolio of $1 billion earning an average of 5% interest, the bank’s interest revenue would be $50 million. On the liability side, the bank has outstanding customer deposits of $1.2 billion earning 2% interest, thus its interest expense is $24 million. As such, the bank generates $26 million in NII ($50 million in interest revenue minus $24 million in interest expense).
Both JPMorgan Chase (JPM) and Bank of America Corp. (BAC), two of the largest financial institutions in the world, like many banks, saw a vast improvement in 2023 over 2022 in NII. JPMorgan Chase’s net interest income increased by 33.81% in 2023, while Bank of America saw an increase of 8.52%. Below is the aggregate NII for American banks in the last two decades:
Beyond Net Interest Income
A bank can earn more interest from its assets than it pays out on its liabilities, but that doesn’t necessarily mean the bank is profitable. Banks, like other businesses, have additional expenses such as rent, utilities, wages, and management salaries. After subtracting these expenses from the NII, the bottom line could be negative.
In addition, banks can also have further sources of revenue besides interest received on loans, such as fees from investment banking or investment advisory services. Investors should consider ancillary revenue sources and expenses beyond NII when evaluating a bank’s profitability.
What Is Net Interest Margin (NIM)?
NIM measures the difference between the interest income generated by a bank’s interest-earning assets (such as loans and mortgages) and the interest expense paid on its interest-bearing liabilities (such as deposits and borrowings). NIM is expressed as a percentage of the bank’s interest-earning assets and is calculated by dividing the NII by the average earning assets and multiplying the result by 100 to get the percentage. For the later 2010s and early 2020s, the NIM for the U.S. fell within a range of 3.25% to 3.75%, with the figures for other major banking economies changing from 1.0% to 2.5%.
What Are Other Important Metrics for Banks?
When evaluating a bank’s performance, there are several key metrics that provide valuable insights into its financial health and operational efficiency. Here are two other important metrics to consider:
How Do Interest Rates Impact Consumers?
Interest rates are the cost of borrowing money. As interest rates increase, borrowers must pay more for their mortgages, cars, credit cards, and other loans, including those loans they already have if they have adjustable rates. Interest rates also affect how much businesses for major expenses like machinery and new products, which are often paid for on credit. This is why, overall, higher interest rates slow down economic activity.
The Bottom Line
Net interest income is a critical financial measure of the profitability of a bank’s core lending and borrowing activities. It is calculated by subtracting the total interest expenses on debts, such as deposits and borrowings, from the total interest income earned on assets like loans and investments.
This calculation helps financial institutions assess the effectiveness of their interest-earning activities and manage the cost of their funding sources, providing greater clarity about how well they manage their interest-based financial operations.
