What Is Net Interest Income?

Net interest income is a financial performance measure that reflects the difference between the revenue generated from a bank's interest-bearing assets and expenses associated with paying on its interest-bearing liabilities. A typical bank's assets consist of all forms of personal and commercial loans, mortgages, and securities. The liabilities are interest-bearing customer deposits. The excess revenue that is generated from the interest earned on assets over the interest paid out on deposits is the 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 according to several factors, such as the type of assets and liabilities that are held as well as if those assets and liabilities have fixed rates or variable rates. Banks with variable rate assets and liabilities will be more sensitive to changes in interest rates than those with fixed rate assets and liabilities.

The type of assets earning interest for the bank can vary greatly from mortgages to auto loans, personal loans, and commercial real estate loans. This will ultimately affect the interest rate a bank earns on its assets and the resulting net interest income after subtracting interest paid out to depositors. Moreover, loans of the same type can carry fixed rates or variables rates. This is most often seen with mortgages as banks offer fixed rate and adjustable rate mortgages.

Quality of the loan portfolio is also a factor affecting net interest income as circumstances like a deteriorating economy and job losses can cause borrowers to default on their loans and lower the bank's net interest income as a result.

Example of Net Interest Income

If a bank has a loan portfolio of $1 billion earning an average of 5% interest, the bank's interest revenue will be $50 million. On the liability side, if the bank has outstanding customer deposits of $1.2 billion earning 2% interest, then its interest expense will be $24 million. The bank will be generating $26 million in net interest income ($50 million in interest revenue minus $24 million in interest expense).

Special Considerations

A bank can earn more interest from its assets than it pays out on its liabilities, but that does not necessarily mean the bank is profitable. Banks, like other businesses, have additional expenses such as rent, utilities, employee wages, and management salaries. After subtracting these expenses from net interest income, the bottom line could be negative. Still, banks can also have additional 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 in addition to net interest income when evaluating a bank's profitability.