What Is a Noninterest Expense?
A noninterest expense is an operating expense of a bank or financial institution that is classified separately from interest expense and provision for credit losses. Examples of noninterest expenses include:
- Employee salaries, bonuses, and benefits
- Equipment rental or leasing
- Information technology (IT) costs
- Rent, telecommunication services, taxes, professional services, and marketing
- The amortization of intangibles
- Noninterest expenses are the fixed operating costs of a bank (e.g., salaries and rent).
- Noninterest expenses are offset by service fees such as fee income from loan originations, late charges on loans, annual fees, and credit facility fees.
- Noninterest expenses are typically higher for investment banks than commercial banks because trading, asset management, and capital markets advisory services are costly.
Understanding Noninterest Expenses
A bank has two main buckets of expenses: interest and noninterest. Interest expenses are incurred from deposits, short-term and long-term loans, and trading account liabilities. A noninterest expense is an expense other than interest payments on deposits and bonds. These expenses are often operational expenses incurred in the daily running of the bank.
A noninterest expense in the case of a bank for a financial institution represents an expense that is not directly associated with attracting and keeping depositor's funds.
The Main Components of Noninterest Expenses
Noninterest expenses are sizeable, and a bank must manage them carefully to maximize its profits. Otherwise, excessive non-interest expenses will directly impact the bottom line.
Noninterest expenses represent the operating expenses of the bank, the majority of which are composed of personnel costs. Occupancy and IT costs are also material cost components, as are professional fees, particularly for legal services to negotiate settlements for past, ongoing, and future fraudulent activities affecting the bank.
In aggregate, the noninterest expense is considered a bank overhead and is used to calculate the overhead ratio of the bank for trend analysis and cross-comparisons with peers. Noninterest expense divided by average assets is the overhead ratio. When an overhead ratio becomes unacceptably high for a prolonged period, a bank will typically address personnel costs first because human capital costs account for the majority of the noninterest expense.
Shareholders in recent years have paid more attention to executive compensation to ensure that managers are not receiving unwarranted pay. Shareholders are typically in favor of competitive compensation, but they want to see that overall personnel costs are within a reasonable range.
Noninterest Expenses by Bank Type
Noninterest expenses are typically higher for investment banks than commercial banks. The main reason is that investment banks rely more on trading, asset management, and capital markets advisory services, which all require higher levels of employee compensation. Lending activities by a commercial bank do not call for Wall Street compensation levels. The differences show up in the numbers.
For instance, in 2020, Morgan Stanley's noninterest expenses composed just over 70% of revenues. Compensation alone made up approximately 45% of revenues. For Wells Fargo, total noninterest expenses and employee costs accounted for 80% and 48% of revenues, respectively.