Advantages of Non-Interest Income

Over the years, corporate banking has become a very important part of the overall banking system. This is because of the fact that banks derive a bulk of their profits from their commercial or corporate banking divisions. Now, the reason that banks derive a larger than usual percentage of their revenue from their commercial banking arm is that commercial banks have several sources of revenue.

Apart from generating their income from interest income, commercial banks generate a lot of non-interest income as well. This income includes fees generated from various services such as bank guarantees, payment transactions, point of sales systems, etc. Up until now, there has been a lot of debate about whether this is a positive point or a negative point for the overall banking industry.

In this article, we will look at the positive aspects i.e. the various benefits which commercial banks derive as a result of having a huge percentage of non-interest income.

  1. Diversification: The first and most important benefit of having a non-interest income is that it leads to diversification for the commercial bank. If a bank is dependent upon interest income, then its income becomes quite erratic since it fluctuates with interest rates. When the interest rate rises, fewer corporations take loans and as a result, the interest income goes down. At the same time, when the interest rate falls, more corporations take loans, and the interest income rises.

    Non-interest income such as credit card fees and payment processing fees are not associated with the interest rate. Rather, they tend to be associated with the scale of operations of the client. Hence, these fees do not vary as much as interest income. Thus, having a significant percentage of income in the form of non-interest income leads to diversification and stabilizes the overall income of the commercial bank even if the external environment is going through different business cycles.

  2. Not Capital Intensive: The problem with interest income is that it is capital intensive. This means that whenever a bank makes a loan, it first needs to have the capital to make that loan. Hence, the proportion of income generated is directly proportional to the amount of capital that they have on hand. This is not the case when it comes to non-interest income.

    The commercial bank earns non-interest income by performing certain services for their clients. Now, the bank needs very little working capital to perform these services. Once the infrastructure has been put in place, they can simply continue to earn income without incurring a lot of expenses periodically. Hence, non-interest income can enable banks to grow their business in a non-linear manner. This means that they can earn more income without investing more capital! This is why many commercial banks prefer non-interest income and try to increase it to the maximum extent possible.

  3. Risk-Free: Whenever banks make a loan, they face credit risk. Hence, in order to generate any interest income, banks have to undertake risk. This is not the case when it comes to non-interest income.

    As already mentioned above, non-interest income is not dependent upon the amount of money that banks can lend out. Since the bank is not lending out any of its money, the question of credit risk does not arise! Also, a typical loan transaction tends to go on for many years. However, transactions that generate non-interest income are executed within a few minutes. Hence, it is a risk-free approach for banks to generate additional income just by making use of the infrastructure which they already have on hand.

  4. Fewer Overheads: Banks require an elaborate mechanism in order to generate interest income. Firstly, they need people to attract depositors. Once the money has been received in the form of deposits, they need a team of people who can lend out this money. Yet another team of people is required to service these loans and collect them from borrowers in the event of a default.

    Needless to say, running all these teams requires a lot of expense. Hence, interest income is associated with many overhead costs. However, when it comes to non-interest income, the situation is different. Non-interest income is usually generated when by using the bank’s information technology systems. Hence, the bank does not have to pay a lot of overheads in order to earn this income.

  5. Stable and Recurring: Also, the non-interest income of a bank tends to be stable and recurring. This is because the payments made by a company to its vendors tend to be stable over time. Hence, the payment processing fees charged by the bank also tend to be stable. In fact, the income tends to grow over time in the same proportion as the business of the client.

    Another feature of non-interest income is that it tends to be recurring. Hence, if a commercial bank is able to onboard a client, it can continue to generate income from the same client for a very long period of time. Thus, there are fewer marketing expenses associated with non-interest income as related to interest income.

The fact of the matter is that non-interest income is an important source of revenue for any commercial banking organization. This is because of the various benefits that this income provides. The benefits have been listed above. However, the benefits should be viewed in conjunction with the disadvantages which will be explained in the next article.

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Commercial Banking