Non-Interest Income

Non-interest income is bank and creditor income derived primarily from fees including deposit and transaction fees, insufficient funds (NSF) fees, annual fees, monthly account service charges, inactivity fees, check and deposit slip fees, and so on. Credit card issuers also charge penalty fees, including late fees and over-the-limit fees. Institutions charge fees that provide non-interest income as a way of generating revenue and ensuring liquidity in the event of increased default rates.

Interest is the cost of borrowing money and is considered a form of income. For financial institutions, such as banks, interest represents operating income, which is income from normal business operations. The core purpose of a bank's business model is to sell money, so as such, its primary source of income is interest, and its primary asset is cash. Banks rely heavily on non-interest income when interest rates are low and tend to use it as a marketing tool when rates are high.

The average firm relies solely on non-interest income. This is the primary way in which the company generates sales. Financial institutions and banks, on the other hand, make money from the sale of money. These firms view non-interest income as a strategic line-item on the income statement. This is especially true when interest rates are low since banks profit from the spread between the cost of funds and the average lending rate. Low interest rates make it difficult for banks to make a profit, so they must rely on non-interest income to make a profit.

Non-interest income can be anything from asset sales to fees for penalties related to overdrafts or withdrawals. Some banks rely heavily on fees from automated teller machines, while other banks rely on general transaction fees. Non-interest income is particularly important in business banking relationships. Banks generally charge businesses and companies more for non-interest transactions.

The degree to which banks rely on non-interest fees to make a profit is a function of the economic environment. Market interest rates are driven by benchmark rates such as the Federal funds rate. The Fed funds rate, or the rate at which banks lend money to one another, is determined by the rate at which the federal reserve pays banks interest. This rate is referred to as the interest rate on excess reserves (IOER). As the IOER increases, banks can make a higher profit from interest income. At a certain point, it becomes more advantageous for the bank to use the reduction of fees and charges as a marketing tool to lure new deposits, rather than as a way to increase profits.