What is net interest income and how is it calculated?
Net interest income is a banking measure that shows how much income a bank earns from interest after paying the interest it owes to depositors and other lenders.
Key takeaways
Net interest income is:
- The difference between the interest revenue a bank earns from lending and the interest expense it pays to depositors and other lenders.
- An important source of operating revenue for many traditional banks.
- Influenced by external economic factors, including the benchmark interest rates set by central banks.
What is net interest income?
When you deposit your savings in a bank, the bank may pay you interest over time. If you borrow money from that same bank, for example through a mortgage, the bank will usually charge interest on the loan.
Net interest income is the income a bank keeps from this interest activity after paying the interest it owes to depositors and other lenders.
In finance, net interest income is one way to understand how a bank earns money from its core role as a lender and deposit-taker. Traditional banks don't typically make most of their money by selling physical products. Instead, they manage the difference between what they earn on loans and other interest-bearing assets, and what they pay on deposits and other funding sources.
Net interest income definition
The formal definition of net interest income is the financial spread calculated by subtracting a bank's total interest expenses from its total interest income. it's an important line item on a financial institution's income statement because it separates revenue generated from interest-bearing assets and liabilities from other revenue streams, such as credit card fees, wealth management commissions or property income.
Meaning of net interest income explained
To understand what net interest income means, it can help to think about a simple markup. Imagine you buy a vintage bicycle at a local car boot sale for $100 and later sell it to a collector for $150. Your retail profit is the $50 difference.
A traditional bank follows a similar idea, although the process is more complex. The bank receives money from depositors and may pay them interest in return. It can then lend some of that money to households, businesses or other borrowers at a higher interest rate.
Net interest income is the amount a bank keeps after collecting interest from its borrowers and paying interest to its depositors and other lenders.
How does net interest income work?
Net interest income is based on two operational columns:
- Interest income (the inflow): this is the cash flowing into the bank from its interest-earning assets. These may include home loans, commercial real estate loans, personal loans, auto financing, credit card balances, government securities and corporate bonds held by the bank.
- Interest expense (the outflow): this is the cash flowing out of the bank to pay for its interest-bearing liabilities. These may include interest paid on standard savings accounts, fixed deposits, current accounts that offer rewards and short-term loans taken from other financial institutions.
Formula
The formula to calculate net interest income is:
If a bank's loan portfolio brings in $10 million in interest and it pays out $4 million in interest to depositors and other lenders, the net interest income is $6 million.
Why is net interest income important?
Net interest income can help investors and analysts assess how much revenue a bank generates from its lending and deposit activities. A higher or rising figure may suggest that the bank has expanded its loan book, improved its lending spread or benefited from changes in interest rates.
However, net interest income does not show the full picture on its own. It should be assessed alongside factors such as credit risk, loan losses, funding costs, operating expenses and wider market conditions. A bank may generate more interest income while also taking on higher lending risk, so context matters.
It can also help show how a bank responds to changing economic cycles. In addition, net interest income can affect how much capital a bank has available to reinvest in technology, hire staff or absorb unexpected loan defaults.
How does net interest income relate to CFD trading?
Net interest income can matter to CFD traders because it helps show how banks earn money from lending and deposits. When a bank reports rising or falling net interest income, traders may use that information as part of wider analysis of bank shares, banking indices or interest-rate-sensitive markets.
With contracts for difference (CFDs), you don’t own the underlying asset. Instead, you trade on its price movement. This means net interest income may be one factor to consider when analysing a bank’s share price, alongside credit risk, loan growth, operating costs, wider market conditions and the risks of leveraged trading.
Real-world net interest income example
Imagine a hypothetical community bank called Horizon Bank that manages a total pool of $100m in customer deposits.
The bank lends out $80m of that cash to local families buying homes at an average mortgage interest rate of 6%. Over the course of the year, those families collectively pay Horizon Bank $4.8m in interest income.
To retain depositors, the bank pays an average interest rate of 2% on the savings accounts holding that $100m pool. Over the same year, the bank distributes $2m in interest expenses to its savers.
By subtracting the $2m expense from the $4.8m revenue, Horizon Bank finishes the fiscal year with net interest income of $2.8m. This cash can contribute to branch running costs, staff salaries, technology investment and other operating expenses.
Create an account Open a demo account