Banks and credit unions experienced ups and downs over the past several years. While low interest rates reduced interest income, most financial institutions experienced an influx in cash deposits. As the economic and financial landscape continues to evolve, institutions must carefully evaluate their income mix.
First, the good news: Banks generate their largest portion of income from interest on loans, and the U.S. Federal Reserve recently hiked interest rates to combat rising inflation, which will encourage continued interest income growth. Some of the biggest U.S. banks have reported year-on-year interest income rate increases ranging from 14% to 26%.
However, financial institutions also face challenges with rising interest rates. For example, while deposits surged during the pandemic as customers saved relief and stimulus funds, deposits are now down at some banks. In response to higher interest rates, financial institutions may also have to pay higher rates for deposits, and changing regulatory capital requirements may soon force them to adjust their asset mix.
To adapt to the higher rate environment, financial institutions should maximize non-interest income sources to maintain profit margins.
Why Is Non-Interest Income Important to Banks?
Non-interest income plays an important role in bank and credit union profitability, especially during an economic slowdown or uncertainty, when they may have difficulties lending money. When financial institutions aren’t earning as much from interest rates, they must rely on other sources to offset those losses.
Non-interest income comes from sources outside of a bank’s core activities of taking deposits and managing loans. Banks and credit unions earn a large portion of non-interest income from fees, such as account service charges, annual fees, deposit fees, and credit card penalties for late payments or exceeding credit limits.
5 Sources of Non-Interest Income for Banks
The majority of non-interest income stems from fees and charges that a bank or credit union collects for certain services. Below, we explore five common sources for generating non-interest income.
1. Service charges and fees
A large portion of non-interest income comes from service charges. These include fees that banks charge for regular banking activities, such as:
- Monthly and/or annual account fees
- Insufficient funds fees
- Inactivity fees
- Deposit and transaction fees
2. Credit card fees and penalties
Customers that hold bank-associated credit cards may pay additional fees and penalties. Issuers may charge annual membership fees, as well as penalties such as late fees and over-the-limit fees.
3. Loan fees
Banks generate a large portion of their income through loan interest. Beyond that, banks may require fees throughout the loan issuing process, including loan origination fees and loan processing fees, which can generate additional income.
4. Wealth management and investment banking functions
Banks may offer wealth management and investment banking services to customers for additional fees. These fees cover managed services, which allows investment professionals at the bank to trade investments on behalf of the client. Banks may also choose to offer additional services to wealth management clients, such as estate or tax planning.
5. Premium banking services
Fees and charges make up the majority of non-interest income; however, banks and credit unions can also generate income by offering premium services to customers. For example, an institution may offer different levels of identity theft protection. Customers could pay more for additional levels of protection if they consider it a valuable service. While some customers may opt to maintain the base layer of protection — which may not require any additional fees — the customers who do choose to pay for the added security will generate non-interest income for the bank.
Identifying the Best Non-Interest Income Sources to Drive Profitability
There are a wide range of non-interest income sources available, so banks and credit unions must focus on identifying which options will most successfully drive profitability.
To start, do you understand which non-interest income sources currently drive revenue? Based on that answer, does your institution appropriately focus on those income drivers, or do you expend unnecessary resources on unprofitable sources? Beyond that, can you identify which customers are most likely to leverage the products and services that generate non-interest income? With this information, you can more effectively price your offerings and promote them to the right audience to maximize profitability. Together, these insights empower your institution to more accurately forecast revenue and cash flow and create a profitable growth strategy.
Advanced profitability tools, such as those in Syntellis’ Axiom™ Financial Institutions Suite, can provide insight into the value of each account, customer, and relationship in your portfolio and the projected earnings each can generate. Axiom also allows your institution to view separate components — including net interest income and non-interest income broken down by category — to see how each element impacts overall profitability. With this visibility, you can adjust your focus to meet profitability goals.
To ensure profitability regardless of the economic environment, banks and credit unions must diversify revenue streams. As your institution explores new avenues for generating income, advanced technology can help determine which revenue streams will add the most value. Learn more about innovative profitability tools and how they can help your institution meet your goals and budgets.