Understanding Net Interest Income

Net interest income can be referred to as a financial performance that shows the difference between the revenue from the interest-bearing assets of a bank alongside the expenses that come with paying on the liability to bear interest. We define a bank asset as every form of loans (commercial and personal), securities, and mortgages. Liabilities, on the other hand, are customer's deposits that generate interest. The extra revenue that comes from the interest accrued on the asset over the part paid to deposit will be the net interest income. 

Explaining Interest Income 

Interest income is the entire interest amount that one earns during a given time frame. We can compare this value to the investment balance to determine the return on investment coming from the business. This interest amount could have been paid in cash, or it might have been collated as earnings that have not yet been paid. 

Recording interest income for the latter case only happens if the cash receipt is possible, and you can deduce the amount of payment you will get.

Interest income comes from an investment that generates interest like a savings account, a deposit certificate, etc. It differs from a dividend that goes to the people that hold the common stock of a company. It can also be a preferred stock that stands for distribution of the issuing company's related earnings. 

The penalty that the customer will pay from overdue accounts can be classified as interest income. These payments are centered on using funds from the company by another party – most often the third party, which is usually the customer. Some companies will specify such income as penalty income. 

Generally, interest income can be taxed, and it is a type of payment that uses the tax rate of ordinary income.

An Example of Net Interest Income 

Let us assume a bank is with a loan portfolio of 2 billion USD earning 5% interest. The interest revenue of the bank will be $100 million. In terms of the liability, assuming the bank is with an outstanding deposit from the customer amounting to $1.5 billion with 3% interest earning, the interest expense generated will amount to $45 million. 

With this, the bank generates a net interest income of $55 million: $100 million as interest revenue minus interest expense of $45 million.

Special Cases

There are times that the earning a bank gets from its asset will be way above its liabilities. This, however, does not mean that the bank is booming. There are additional expenses with running a bank like other businesses. Such payments could be utilities, rent, salaries, and wages for all workers and employers. 

When all these expenses are removed from the net interest income, what is left might not be positive. However, there could be an additional source of revenues for banks asides from the interest that comes from loans like investment banking. 

In evaluating the profitability of a bank, investors should note the ancillary revenue expenses and sources.

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