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 12
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 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 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 3