What Is Net Interest Income and How Is It Calculated?

Net interest income is the money a bank keeps from the spread between what it earns on loans and investments and what it pays to depositors and other creditors. The formula is simple: total interest income minus total interest expense. If a bank collects $500 million in interest from borrowers and bondholders and pays out $200 million to depositors and lenders, its net interest income is $300 million. That figure is the core of bank profitability, reported before loan losses, salaries, or any other operating cost. As of the fourth quarter of 2025, the U.S. banking industry reported an aggregate net interest margin of 3.39%, the highest level since 2019.¹

You’ll see this number, usually abbreviated NII, near the top of any bank’s income statement, and again in more granular form on the quarterly Call Reports banks file with the FFIEC.²

Where the Interest Income Comes From

The loan portfolio does most of the work. Commercial loans, consumer credit, and mortgages are the highest-yielding assets on most bank balance sheets, and the interest borrowers pay flows straight into the top of the NII calculation. A bank with a $10 billion loan book yielding an average of 6% is generating $600 million a year from loans alone.

Investment securities are the second major source. Banks hold portfolios of government bonds, agency mortgage-backed securities, and corporate debt. Yields on these tend to be lower than on loans, but so is the credit risk, and the portfolio doubles as a liquidity buffer the bank can sell if it needs cash.

Smaller amounts come from money placed with other institutions. Federal funds sold, which is overnight lending to other banks, and securities purchased under resale agreements both produce interest income and appear as distinct lines on the Call Report.² The blend of loans, securities, and interbank placements determines the bank’s weighted average asset yield, which is the revenue half of NII.

Where the Interest Expense Comes From

Customer deposits are the biggest cost for most banks. Interest paid on savings accounts, certificates of deposit, money market accounts, and interest-bearing checking all count. In the recent rate cycle, the average cost of interest-bearing deposits has been a critical pressure point, because depositors have demanded higher rates to keep money at the bank rather than moving it to Treasury bills or money market funds.

Banks also raise money in wholesale markets. Short-term borrowings, Federal Home Loan Bank advances, and subordinated debt all carry interest costs.² Wholesale funding reprices faster than retail deposits, which can help or hurt depending on where rates are heading.

The best funding is free. Non-interest-bearing demand deposits are checking accounts on which the bank pays nothing, and Call Report instructions explicitly leave them out of interest expense.² A bank with a large base of free checking has a much lower blended cost of funds. Two banks with identical asset yields can post very different NII if one runs on free checking and the other on high-rate CDs. Deposit composition is one of the first things worth checking.

Net Interest Margin: Comparing Banks of Different Sizes

Raw NII in dollars is useful for tracking one bank over time. It is close to useless for comparing a $2 trillion bank against a $5 billion community bank. Net interest margin solves that by expressing NII as a percentage of average earning assets:

NIM = Net Interest Income / Average Earning Assets

Average earning assets covers everything on the balance sheet that produces a yield: loans, investment securities, and interbank placements. The average is built from daily or weekly balances over the reporting period, not a single snapshot.² The Federal Reserve defines the yield on total earning assets as total interest income divided by that average, and NIM is that yield minus the cost of funding those assets.³

In Q4 2025, the industry NIM was 3.39%, and community banks reported 3.77%.¹ Community banks tend to run higher because they hold a larger share of loans relative to securities and fund themselves mostly with core deposits. When NIM compresses quarter after quarter, funding costs are rising faster than asset yields, which is often the first warning sign of earnings pressure.

What Pushes Net Interest Income Up or Down

NII is not static. It responds to external rate conditions and to internal management choices, and the interaction between them is where most of the interesting analysis happens.

Federal Reserve Rate Decisions

The biggest external lever is the Fed’s target for the federal funds rate, currently 3.50% to 3.75%. When the Fed moves, the whole rate structure moves with it: banks can charge more on new variable-rate loans, and they also face pressure to pay more on deposits.⁴ Whether a rate change helps or hurts NII depends entirely on which side of the balance sheet moves first.

Asset Sensitivity vs. Liability Sensitivity

A bank whose assets reprice faster than its liabilities is asset-sensitive. When rates rise, loan yields climb before deposit costs catch up, widening the spread and lifting NII. A liability-sensitive bank sees the opposite: funding costs jump first, and NII compresses until asset yields catch up.⁵ Most U.S. commercial banks have been modestly asset-sensitive in recent years, which is why the 2022–2024 hiking cycle initially expanded industry margins.

Deposit Beta

Deposit beta measures how much of a Fed rate increase a bank actually passes through to depositors. A beta of 0.50 means a 100-basis-point Fed hike turns into a 50-basis-point rise in what the bank pays on deposits.⁶ Community banks in the recent cycle passed along less than half of the cumulative Fed hikes to depositors during much of the run-up, which is what widened margins early on.⁷ Betas usually rise over time as depositors become rate-conscious and shift money into higher-yielding options, and that catch-up is what compressed margins later in the same cycle.

The Yield Curve

Banks borrow short and lend long. A steep curve, where long-term rates sit well above short-term rates, produces a natural spread that supports NII. A flat or inverted curve compresses it. The effect is not uniform: a bank funded mostly by stable retail deposits may actually see NIM widen during a flattening episode because its funding barely moves, while one leaning on wholesale funding gets squeezed quickly.⁸

Loan Volume and Asset Mix

Internal choices matter just as much. Growing the loan book puts more earning assets to work and lifts NII directly. The composition of that book also matters: commercial real estate and credit card loans yield more than government securities, so tilting the mix toward higher-yielding categories raises the return while adding credit risk. A bank that keeps excess cash in Treasuries instead of lending will post a lower NIM even in a friendly rate environment.

When Interest Income Disappears: Non-Accrual Loans

Not every loan pays what it promised. When a borrower stops paying, the bank eventually has to stop counting that interest as income. Federal regulatory guidance requires a loan to be placed on non-accrual status when it is 90 days or more past due, unless it is both well-secured and actively being collected.⁹

Two things happen to NII when that flip occurs. Future interest stops being recorded, so revenue falls going forward. And any interest already accrued in the current calendar year but not yet collected in cash has to be reversed directly against the interest income line, reducing reported NII for the period.⁹ Once reversed, that interest cannot come back unless the bank actually receives the cash. A sudden jump in non-performing loans can pull NII down even when rates and lending volume are unchanged.

The Provision for Credit Losses Is Separate

One point of confusion worth clearing up. The provision for credit losses sits on the income statement right below NII, and the two often get lumped together. They are different. NII measures the interest spread the bank actually earned. The provision is a separate expense representing the bank’s estimate of future loan losses under current expected credit loss (CECL) accounting. Some analysts refer to “net interest income after provision” as a combined figure, but the provision is a credit cost, not an interest cost.

The distinction matters. A bank can post strong NII growth while also raising its provision, which may mean it is lending harder into riskier segments. Flat NII paired with a falling provision may reflect improving credit quality that helps the bottom line. Two different stories, two different risks.

Tax-Equivalent Adjustments

Interest on municipal bonds is generally exempt from federal income tax. That creates a comparison problem: a 3% muni yield is not really the same as a 3% taxable corporate loan yield. Many banks report a tax-equivalent NII that grosses up the tax-exempt income to a pre-tax basis. The adjustment divides the tax-exempt yield by one minus the bank’s tax rate. A muni yielding 3% held by a bank in a 21% federal bracket has a tax-equivalent yield of about 3.80% (3% divided by 0.79). When you see “NII on a fully tax-equivalent basis” in a bank’s earnings release, that is what they are doing, and the gap between reported NII and tax-equivalent NII tells you how sizable the muni portfolio is relative to everything else.

Reading Net Interest Income in Context

NII by itself is a starting point, not a verdict. Rising NII driven by aggressive lending into high-risk segments can look great for two quarters before credit losses erase the gains. Falling NII at a bank that is deliberately shrinking a low-return loan book may actually reflect a better strategy. The useful read combines NII trends with NIM movement, deposit beta trajectory, non-performing asset ratios, and provision levels. In Q4 2025, industry NIM rose because funding costs fell faster than asset yields, driven by Fed rate cuts feeding through to deposit pricing while existing fixed-rate loans held their yields.¹ Context turns a headline number into something you can actually use.

1
FDIC. FDIC Quarterly Banking Profile Fourth Quarter 2025
2
FFIEC. Instructions for Preparation of Consolidated Reports of Condition and Income
3
Federal Reserve Board. A Users Guide for the Bank Holding Company Performance Report
4
Federal Reserve Board. The Fed Explained – Monetary Policy
5
Federal Reserve Board. Focusing on Bank Interest Rate Risk Exposure
6
Federal Reserve Bank of St. Louis. Higher Deposit Costs Continue to Challenge Banks
7
Federal Reserve Bank of Kansas City. Community Bank Deposit Pricing Becoming More Sensitive
8
Federal Reserve Bank of Chicago. How Have Banks Responded to Changes in the Yield Curve
9
eCFR. Appendix B to Part 741 – Loan Workouts, Nonaccrual Policy, and Regulatory Reporting