Net interest income is the difference between the interest a bank earns on its loans and investments and the interest it pays out on deposits and other borrowing. For most traditional banks, it is the single largest source of revenue, which is why it sits at the centre of every set of bank results. With major US banks opening the third-quarter reporting season this week, it is one of the numbers traders will watch most closely.
How it works
A bank takes in money from savers and lends it out to households and businesses, or invests it in assets such as government bonds. It charges borrowers more than it pays savers, and the gap is its profit on lending. If a bank earns an average of, say, several percentage points on its loans and pays much less on its deposits, the difference across billions in balances adds up to a large income stream. That income, after deducting interest costs, is net interest income.
A related measure is the net interest margin, which expresses that income as a proportion of the assets that earn interest. It shows how profitable each unit of lending is, and allows comparisons between banks of different sizes.
Why interest rates matter so much
Because banks earn and pay interest, changes in central bank rates feed directly into net interest income. When rates rise, banks can usually increase the interest they charge on loans quickly, especially on variable-rate products. They often raise the rates paid to savers more slowly. That timing gap tends to widen margins, which is why bank shares often benefit in the early stages of a rate-rising cycle.
The reverse can happen when rates fall. Loan income can drop faster than deposit costs, squeezing margins. That is why markets watch central bank expectations closely when judging the outlook for banks. Our piece on what higher for longer means for interest rates explores that backdrop.
The shape of the yield curve
It is not just the level of rates that matters. Banks often borrow short term, through deposits, and lend longer term, through mortgages and business loans. When long-term rates are well above short-term rates, a steep yield curve, that model tends to be more profitable. When the curve is flat or inverted, with short-term rates close to or above long-term ones, margins can come under pressure. Our guide to why bond prices fall when yields rise offers useful background on how yields behave.
What traders look for in results
The headline net interest income figure matters, but guidance on where it is heading often matters more. Many large banks give an outlook for the year, and changes to that outlook can move shares sharply. Traders also look at deposit trends, because if customers move money into higher-paying accounts or out of the bank altogether, funding costs rise. Loan growth matters too, as more lending can offset narrower margins. Our explainer on how US bank earnings season works covers the wider set of numbers.
Not the whole story
Banks also earn fees from activities such as investment banking, trading, wealth management and card payments. For some large global banks, these sources are substantial and can offset weaker lending income. Costs and provisions for bad loans also matter. A bank with rising net interest income can still disappoint if it has to set aside more money for loans that might not be repaid, often a sign that it expects tougher economic conditions.
Common beginner mistakes
The first is assuming higher rates are always good for banks; very high rates can hurt borrowers and raise bad debts. The second is ignoring deposit costs. The third is focusing on the headline figure and missing changes to guidance. The fourth is treating all banks alike, when their mix of lending, fees and funding can differ widely.
Bringing it together
Net interest income is the engine of most banks’ profits, driven by interest rates, the yield curve, deposits and loan growth. Reading it alongside guidance, fees and bad-debt provisions gives a clearer view of a bank’s health.
If you want to check how ready you are to trade around company results with a clear plan, our free trader assessment is a practical next step.
