What is Non-Interest Income?

The non-interest income is the revenue generated from the non-core activities by the banks and financial institutions (loan processing fee, late payment fees, credit card charges, service charges, penalties, etc.). It plays a vital role in its overall profitability.

Explanation

  • The core activity of any bank or financial institutionFinancial InstitutionFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more is to accept deposits and from the accumulated deposits bank lends money. Thus, a bank earns interest income by lending money to the borrowers at a higher rate and paying interest on the deposit accounts at a relatively lower rate. The net interest income is the difference between the earned and paid. Thus, in the banking business models, the net interest income is the net interest incomeNet Interest IncomeNet Interest Margin is a popular profitability ratio used by banks which helps them determine the success of firms in investing in comparison to the expenses on the same investments. It is calculated as Investment income minus interest expenses (this step is referred to as netting) divided by the average earning assets.read more. Thus, in the banking business models, the net interest income is the operating revenueOperating RevenueOperating revenue is defined as revenue earned by an individual, corporation, or organization from the core activities that they undertake on a regular basis. There are several methods to earn revenue, but operational revenue is earned by the core business activities that the organization undertakes in its daily operations.read more generated from the core activities of the business.The total income of any Bank or financial institution is the sum of interest income and non-interest income. However, it is not the only source of income a bank or financial institution may have during the year of operation. The other revenue streamsRevenue StreamsRevenue streams refer to the different sources through which the company generates profit, such as selling the products, catering the services or offering a combination of goods and services to the clients.read more are not directly attributed to lending the money.

You are free to use this image on you website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Non-Interest Income (wallstreetmojo.com)

Examples of Non-Interest Income

  • ·       For example, assume XYZ Bank lent the US $ 1000,000 to ABC Inc. at the rate of 6% p.a. for ten years equated to repayment. Let us assume the bank earned a total interest income of US $ 60,000 from ABC Inc. However, at the time of sanction of the loan, XYZ bank charged 0.5% of the loan amount towards the Loan origination fee, an upfront payment of US $ 500 towards the other service charges.The amount of US $ 5000 (as Loan origination fee) and the US $ 500 (as other service charges) is also income for the bank, but this US $5,500 is not coming from interest charges. Thus this income is classified in the books of XYZ Bank as Non-Interest Income.

List of Non-Interest Income for Banks

List of Non-interest income includes income earned from the non-core activities of the banking business, such as:

  • Loan processing feeLoan origination feeLate payment charges,Foreclosure chargesOver limit charges,Credit card annual charges,Cheque book issue chargeInsufficient funds charges,Service chargesDishonor chargesPenalties

Significance

  • Generally, for any business that manufactures or trades goods or provides any service, the non-interest income is considered the revenue generated from the core business activities such as the sale of goods or services. However, only in the case of banking and the financial institution the interest income is considered revenue generated from core activities. It is considered income from non-operating activities of the business. It is because the critical operational activity for any bank or financial institution is accepting money deposits and lending moneyHowever, it becomes significantly important during the economic slowdown or financial crisisFinancial CrisisThe term “financial crisis” refers to a situation in which the market’s key financial assets experience a sharp decline in market value over a relatively short period of time, or when leading businesses are unable to pay their enormous debt, or when financing institutions face a liquidity crunch and are unable to return money to depositors, all of which cause panic in the capital markets and among investors.read more when the banks face difficulties in lending money or when the bank lends money at lower interest rates. Due to any of these, banks struggle to maintain their margins. In such scenarios, the earning inflow from other non-interest income becomes crucial for the banks to offset the loss due to the lower interest rate.The following table shows the last ten-year trend of interest income and non-interest income of all the US commercial banks. One can observe that when the interest incomeInterest IncomeInterest Income is the amount of revenue generated by interest-yielding investments like certificates of deposit, savings accounts, or other investments & it is reported in the Company’s income statement. read more of the banks decreased in 2009 due to the financial crisis when banks were not ready to lend any additional money, the % of non-interest income increased significantly.

Non-Interest Income as a % of Interest Income

United States Commercial Bank (US $ in millions)

Drivers of Non-Interest Income

  • The extent of non-interest income variation is counted on economic scenarios. The interest income largely depends on the minimum rate of interest charged on the sanctioned loan value. The interest rate is based on the Federal Bank’s benchmark rate. Now, when the economy faces challenges of deflationDeflationDeflation is defined as an economic condition whereby the prices of goods and services go down constantly with the inflation rate turning negative. The situation generally emerges from the contraction of the money supply in the economy.read more, as a preventive measure Federal Bank lower the interest rates.In such a case, the banks are supposed to pass down the credit of reduction in interest rates to the consumers. It is done by revising the rate of interest charged on the loans. It leads to a fall in the interest income of the bank. To offset the revenue fall, the banks slightly increase the charges levied on transactions that constitute the non-interest income.Likewise, when the economy goes through inflation, the Federal bank raises the interest rate to increase the cost of borrowing to control the price hikes. It increases the interest income.However, non-interest income falls because the consumer avoids borrowing the money at the higher cost of funds, which results in a decrease in loan origination changes, loan serviceLoan Origination Changes, Loan ServiceLoan Servicing is a process in which entities known as loan servicers perform various administrative tasks related to loan repayments on behalf of the lender or loan originator (banks or other financial institutions), such as collecting interest and principal, paying insurance and taxes, and posting statements on a regular basis to the loan borrower in exchange for a predetermined fee.read more charges, late payment charges, etc.

Conclusion

The non-interest income is generated from non-core activities of banking and financial institutions. It plays a vital role in the overall total income of the banks. Mostly, the non-interest income is affected by the extent of interest income.

This has been a guide to What is Non-Interest Income & its Definition. Here we discuss the list of non-interest income in Banks, its significance, and examples and drivers. You can learn more about it from the following articles –

  • Formula of Interest ExpensePIK InterestFormula of Net IncomeConsequential Loss