Noninterest ExpenseExplained & Defined
Noninterest expense refers to a bank’s operating expenses such as personnel salaries and bonuses, rent or lease expenses, IT expenses, professional fees, marketing, and other expenses related to the bank or financial institution’s operations.
The classification of non-interest expenses is different from credit losses and interest expenses on the deposits of the customers.
Understanding Noninterest Expenses
Bank operations classify their expenses into two: Noninterest Expenses and Interest Expenses.
Interest expenses are those that are directly related to the expenses incurred from short-term and long-term loans, credit cards, and trading account liabilities.
All other expenses related to the operations of the business are referred to as non-interest expenses.
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.
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
Between Investment Banks and Commercial Banks, it is the Investment Banks that record higher noninterest expenses because their activities are focused on investment activities such as asset management, capital market advisory, issues related to IPOs, and trading – all requiring high employee involvement and therefore, high personnel costs.
Commercial Banks deal mostly with lending activities and have lower employee involvement than Investment Banks.