What is a Non-Interest Expense?

What is a Non-Interest Expense?

A non-interest expense is an operating expense incurred by a bank, and it is separate from the interest expense on customer deposits.

A non-interest expense is an operating expense incurred by a bank, and it is separate from the interest expense on customer deposits. It includes the bank’s operating and overhead expenses, such as employee salaries and bonuses, unemployment tax, operating and maintenance of facilities, equipment rental, marketing, insurance, furniture, and amortization of intangibles.

Generally, non-interest expenses are essential to the day-to-day operations of a bank, and therefore, the bank needs to keep its operational costs at an optimal level to maximize its annual profits.

If the operational costs are not properly managed, they will directly affect profits. A bank’s non-interest expense is usually offset by service fees from loan origination, annual fees, credit facility fees, and late charges on loans.

Understanding Noninterest Expenses

A bank has two main buckets of expenses: interest and noninterest. Interest expenses are incurred from deposits, short-term and long-term loans, and trading account liabilities. A noninterest expense is an expense other than interest payments on deposits and bonds. These expenses are often operational expenses incurred in the daily running of the bank.

The Main Components of Noninterest Expenses

Noninterest expenses take up the majority of the expenses of a bank and if they are not managed well, it could directly impact the profits.

The non-interest expenses are sizable and mainly include personnel cost, rent or leasing expenses, IT expenses, legal and professional fees, stationery, and other operating expenses.

Given the sizable amount that the non-interest expense contributes to the determination of the profitability of a bank, they are considered overheads and are used in the computation of the Overhead Ratio, which is computed by dividing noninterest expenses by the average assets.

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The ratio is useful for trends analysis and comparisons between peers.

In the event that the Overhead Ratio is too high and remains that way for a long time, the first noninterest expense that is usually addressed is personnel costs because it accounts for the majority of the noninterest expenses.

A lower Overhead Ratio is always preferred by banks and while the shareholders would want their personnel to receive competitive compensation, they would want that to be within a reasonable range.

Noninterest Expenses by Bank Type

Noninterest expenses are typically higher for investment banks than commercial banks. The main reason is that investment banks rely more on trading, asset management, and capital markets advisory services, which all require higher levels of employee compensation. Lending activities by a commercial bank do not call for Wall Street compensation levels. The differences show up in the numbers.

For instance, in 2020, Morgan Stanley’s noninterest expenses composed just over 70% of revenues. Compensation alone made up approximately 45% of revenues.1 For Wells Fargo, total noninterest expenses and employee costs accounted for 80% and 48% of revenues, respectively.