Prof. Dr. Rainer Stachuletz
Banking Academy of Vietnam
Based upon: Bank Management, 6th edition.
Timothy W. Koch and S. Scott MacDonald
MANAGING NONINTEREST
INCOME & NONINTEREST
EXPENSE
Chapter 3
Prof. Dr. Rainer Stachuletz – Banking Academy of Vietnam - Hanoi
Issues
in Interest
Income
 Deregulation
in the
1990sand
leadInterest
to an
Expense
increase in competition
 Average NIM fell since 1992 due to this
increased competition
Net Interest Margin over Time
1992
4.32%
4.50%
4.00%
3.50%
2004
3.61%
3.00%
2.50%
2.00%
1.50%
1945
1.46%
1.00%
'34
'39
'44
'49
'54
'59
'64
'69
'74
'79
'84
'89
'94
'99
'04
Net Interest Margins by Bank Asset Size,
1992–2004
5.0%
Net Interest Margins
4.8%
4.6%
$100M - $B
4.4%
< $100M
4.2%
4.0%
> $1B
3.8%
3.6%
3.4%
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Issues
in
Interest
Income
and
Interest
 Core deposit growth has slowed due
Expense
to “disintermediation”
 Loan yields have fallen on a relative
basis due to credit scoring and
increased competition among lenders
 NIM is being squeezed, so banks must
concentrate more on non-interest
income to grow profits.
Issues
in
Non-Interest
Income
and
 Banks must rely less on net interest
Non-Interest Expense
income and more on non-interest
income to be more successful
 Banks
must grow their non-interest
income relative to non-interest
expense if they want to see net income
grow.
Issues
in
Non-Interest
Income
and
 The highest earning banks will be
Non-Interest Expense
those that generate an increasing
share of operating revenue from noninterest sources, like fee income
 All
fees are NOT created equal
Some fees are stable and predictable
over time, while others are highly
volatile because they are cyclical
 Consider NSF charges on checkwriting

Sources of Non-Interest Income
 Fiduciary Activities
 Deposit Service Charges
 Trading Revenue, Venture Capital Revenue, and






Securitization Income
Investment Banking, Advisory, Brokerage, and
Underwriting Fees and Commissions
Insurance Commission Fees and Income
Net Servicing Fees
Net Gains (Losses) on Sales of Loans
Other Net Gains (Losses)
 Sale of premises and other fixed assets
Other Non-Interest Income
 Safe Deposit, Money Order & Notary Fees
Non-Interest Income is increasing as a
 Largest contributors
arerevenue
deposit
proportion
of net operating
service charges and other non-interest
income
 Largest banks rely more on noninterest income than their smaller
counterparts
0.0%
Other
noninterest
income
Net gains
(losses) on
other assets
< $100M
>$1B
Investment
banking,
advisory,
brokerage,
Net gains
(losses) on
sales of loans
and other
Net servicing
fees
0.6%
Trading,
venture cap.
and
securitizations
Fiduciary
activities
Deposit
service
charges
Composition of Noninterest Income by Bank
Size as a Percentage of Total Assets, 2004
0.8%
0.7%
$100M-$1B
All Comm. Banks
0.5%
0.4%
0.3%
0.2%
0.1%
Non-Interest income is increasing as a
proportion of net operating revenue
Trends in Net Interest Income and Non-interest Income
90%
90%
80%
80%
70%
60%
70%
Net Interest Income
60%
50%
50%
40%
40%
30%
20%
Noninterest Income
Actual Data
Predicted
30%
10%
20%
0%
10%
1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009
Deposit
Service
Fees
 Stable source of revenue
 Relatively price inelastic
 What level of fees is too high given a
bank’s desire for strong customer
relationships?
Deposit Service Fees:
Non-Interest Checking Accounts
 Single-Balance, Single-Fee
 No fee if minimum balance is met;
otherwise monthly fee
 Account Fee-Only
 Monthly fee regardless of balance
plus a possible per-check-charge
 Free
 No fees of any kind
Fee Structures by Bank Size and Type of
Services, 1999 and 2002: Noninterest Checking
Account availability and fee averages
Dollars except as noted
Percent offering noninterest checking
Single-balance, single-fee account 1
Percent offering
Monthly fee (low balance)
Minimum balance to avoid fee
Minimum balance to open
Fee-only account 2
Percent offering
Monthly fee
Check charge
Percent charging
Average
Minimum balance to open
Free account 3
Percent offering
Minimum balance to open
1999
Institution Size
All
Large Medium Small
93.10
96.10
92.90 93.00
37.20
6.17
517.72
109.05
50.80
8.20
723.01
102.61
37.30
4.95
64.50
5.02
42.80 32.70
5.05 4.88
36.80
0.39
60.98
38.50
0.63
56.73
13.60
41.87
21.90
53.66
2002
Institution Size
All
Large Medium Small
96.10
96.90
97.00
95.40
42.30 33.80 32.30
6.77 5.58
7.35
583.42 455.61 591.46
108.03 110.37 159.21
39.40
9.75
890.43
122.72
32.20
7.77
582.00
136.88
31.80
6.78
566.28
179.61
39.90
5.27
64.80
6.09
44.90
5.25
34.10
5.14
45.30 31.10
0.45 0.30
65.47 58.68
23.70
0.22
78.41
4.70
NS
98.29
25.00
0.26
70.22
24.70
0.19
82.98
16.50 11.50
53.63
NS
30.10
73.82
38.20
NS
31.20
66.27
28.60
73.65
Deposit Service Fees:
Interest-Bearing Checking Accounts
 Single-Fee NOW Accounts
 No
fee if minimum balance is met,
otherwise monthly fee
 Single-Fee, Single Check NOW
Account
 Monthly
fee regardless of balance plus
a possible per-check-charge
 No-Fee NOW Accounts
 No
fees of any kind
Fee Structures by Bank Size and Type of
Services, 1999 and 2002: Interest Checking
Account availability and fee averages
Dollars except as noted
All
1999
Institution Size
Large Medium Small
All
2002
Institution Size
Large Medium Small
Percent offering NOW
(interest checking) Accounts
93.3
90.8
96.7 91.8
95.6
96.8
96.4
95
Single-fee account 1
Percent offering
51.9
51.8
49.6
53
40.9
53.2
40.1
40.5
Monthly fee (low balance)
8.24
10.37
8.5 7.97
8.71
10.05
9.13
8.26
Minimum balance to avoid fee
1,014.23 1,444.78 1,096.75 946.6 1,090.78 1,755.94 1,048.41 1,049.79
Minimum balance to open
587.23 431.34 393.36 686.62
469.59 606.54 449.47 469.37
Single-fee, single-check-charge account 2
Percent offering
12.4
12.2
9.6 13.8
12.5
17.5
12.3
12.3
Monthly fee (low balance)
6.35
6.84
7.08 6.07
7.06
7.83
7.28
6.82
Check charge
0.21
0.33
0.23 0.19
0.25
0.33
0.24
0.24
Minimum balance to avoid fee
1,002.25 1,543.02 941.09 988.84 1,034.36 1,407.35 1,007.07 1,010.71
Minimum balance to open
683.4 634.27 459.07 762.13
591.05 388.12
392.3 760.15
No-fee account
Percent offering
0.9
0.3
1
0.9
1.8
7.2
1.3
1.7
Minimum balance to open
1
199.44
NS
NS
NS
NS
NS
NS
Deposit Service Fees:
Special Fees
 NSF Checks
 Check
is returned
 Overdrafts
 Check
is honored
 Deposit Items Returned
 Stop-Payment Order
Fee Structures by Bank Size and Type of
Services, 1999 and 2002: Special account fees
Account availability and fee averages
Dollars except as noted
All
Special Account Fees
Stop-payment orders average fee
NSF checks average fee 1
Overdrafts average fee 2
Deposit items returned average fee
15.26
17.88
17.66
6.33
1999
Institution Size
Large Med. Small
20.46
22.84
22.95
7.47
17.61
20.05
20.24
6.37
13.70
16.43
15.97
6.16
All
18.93
21.73
21.80
6.88
2002
Institution Size
Large Med. Small
23.54
26.19
26.84
6.13
21.06
23.41
23.69
6.82
17.00
20.14
20.00
7.03
Deposit Service Fees:
ATM Services
 Annual Fees
 ATM Card Fees
 “On us” Withdrawal Fees
 Fees
levied on bank’s own customers
for withdrawals from the bank’s own
ATMs
 “On others” Withdrawal Fees
 Fees
levied on bank’s own customers
for withdrawals from another bank’s
ATM
Fee Structures by Bank Size and Type of
Services, 1999 and 2002: Special account fees
Account availability and fee averages
Dollars except as noted
All
Automated teller machines
Percent offering ATM card
Percent charging annual ATM fee
Average fee $
Percent charging ATM card fee
Average fee $
Percent charging “on others” ATM fee
Average fee $
Percent charging ATM surcharge fee
Average fee $
83.10
16.20
7.97
7.70
4.16
72.00
1.17
81.50
1.25
1999
Institution Size
Large Med. Small
96.20
13.10
15.47
2.60
NS
87.20
1.27
85.30
1.36
97.20
10.20
7.35
4.10
5.18
75.70
1.23
86.70
1.28
75.30
20.30
7.83
10.40
3.92
68.20
1.12
77.60
1.21
All
93.40
10.30
11.65
4.00
6.39
69.00
1.14
89.40
1.36
2002
Institution Size
Large Med. Small
98.80
5.50
NR
1.20
NS
76.90
1.31
93.50
1.42
98.00
7.20
9.77
1.80
NS
78.50
1.21
92.20
1.38
89.60
13.20
12.25
6.00
5.73
60.70
1.04
86.60
1.33
The UBPR lists five components of noninterest expense:
 Personnel Expense
 Occupancy Expense
 Goodwill Impairment
 Other Intangible Amortization
 Other Operating Expense
Cost savings in these areas often
drive bank mergers
Non-Interest
Expense:
Key
Ratios
 Burden
 Lower
is better (Burden > 0)
Burden Non - InterestExpense - Non - InterestIncome
 Net Non-Interest Margin
Burden
Net Non - Interest Margin 
Average Total Assets
 Lower
is better
Non-Interest Expense: Efficiency Ratio
 Efficiency Ratio
Non - Interest Expense
Efficiency Ratio 
 Larger banks
tendIncome
to have
lower
Net Interest
 Non
- Interest Income
(better) efficiency ratios because they
generate more non-interest income
 Low efficiency ratios do not always
lead to higher ROEs
Efficiency Ratios of U.S. Commercial
Banks, 1992–2004
75.0%
70.0%
<$100M
60.0%
$100M-$1B
55.0%
>$1B
Dec-04
Dec-03
Dec-02
Dec-01
Dec-00
Dec-99
Dec-98
Dec-97
Dec-96
Dec-95
Dec-94
Dec-93
50.0%
Dec-92
Efficiency Ratio
65.0%
Non-Interest Expense:
Operating Risk Ratio
 Operating Risk Ratio
Non - Interest Expense - Fee Income
Operating Risk Ratio 
Net Interest Margin

Lower is better because proportionally
more income comes from fees
Operating Risk Ratio Signals the Benefit
of Fee Income
Ratio
Return on assets (ROA)
Net interest margin (NIM)
Percent of average total assets:
Net interest income
Noninterest income (fee)
Operating revenue
Noninterest expense
Earning assets
Taxes
Efficiency Ratio:
Operating Risk Ratio:
Bay Bank
River Bank
1.40%
4.000%
1.40%
4.625%
3.20%
1.40%
4.60%
3.00%
80.00%
0.20%
65.22%
=0.03 / (0.032 + 0.014)
40.00%
= (0.03 - 0.014) / 0.04
3.70%
0.90%
4.60%
3.00%
80.00%
0.20%
65.22%
=0.03 / (0.037 + 0.009)
45.41%
= (0.03 - 0.014) / 0.04625
Non-Interest Expense:
Productivity Ratios
 Productivity Ratios
 Assets
per Employee
Assets Per Employee 
 Average
Average Assets
Number of Full - Time Employees
Personnel Expense
Average Personnel Expense 

Personnel Expense
Number of Full - Time Employees
Can be biased on the high side due to
senior management compensation
Community banks often examine two
additional productivity ratios
 Loans per Employee
Average Loans
Loans Per Employee 
Number of Full - Time Employees
 Net Income per Employee
Net Income
Net Income Per Employee 
Number of Full - Time Employees
 Loans
typically represent the largest
proportion of assets for community
banks
Line-of-Business
Profitability
 Risk-Adjusted Return on Capital
Risk - Adjusted Income
RAROC 
Capital
 Return on Risk-Adjusted Capital
Income
RORAC 
Allocated Risk Capital
Customer
Profitability
 Analyses of customer profitability
profiles suggest that banks make most
of their profit from a relatively small
fraction of customers.
 View
is that 20% of a bank’s customers
account for 80% of profits.

This supports the increase in fees
assessed by most banks over the past
few years.
Percent of Total Profits
Customer Profitability 80–20 Rule
80
70
60
50
40
30
20
10
0
-10
Who are they, what do they need?
How do you move them up?
Move up or move
out
High Value
Customers
Value
Customers
Average
Customers
Low Value
Customers
High
Maintance
Customers
Customer Profitability:
Expense Components
 Non-Credit Services
 Check-processing expenses are the major
non-credit cost item for commercial
customers
 Transaction Risk
 Risk of fraud, theft, error, and delays in
processing, clearing, and settling payments
 Credit Services
 Cost of Funds
 Loan Administration Expense
 Default Risk
 Business Risk Expense
 Losses and allocations for potential losses
Customer Profitability:
Revenue Components
 Investment Income from Deposit
Balances
 Earnings
Credit
 Non-Interest Income
 Fee
Income
 Loan Interest
Customer Profitability:
Aggregate Profitability Results
 Profitable customers maintain multiple
relationships with the bank
 Unprofitable customers tend to “shop”
for the lowest price and do not use
multiple products
Appropriate Business Mix
 Manage Fee Income in a Portfolio Context

One suggestion:



30% - Deposit Activities
10% - 15% - Investment Banking and Trading
55% - 60% - Specialty Intermediation and FeeBased Operating Business
 Consumer Finance
 Specialty Leasing
 Factoring
 Insurance
 Mutual Funds
 Investment Management
Percentage of Various Components of
Total Noninterest Income, 2004
Percentage of Total Noninterest Income
Deposit service charges
Fiduciary activities
Trading, venture cap. and securitizations
Net servicing fees
Investment banking, advisory, brokerage, and
insurance
Insurance commissions and fees
Net gains (losses) on sales of loans and other
assets
Net gains (losses) on other assets
Other noninterest income
<
$100M
45.7%
8.7%
0.0%
8.7%
$100M$1B
30.7%
13.6%
4.3%
4.3%
>$1B
15.9%
12.2%
18.3%
8.5%
All
Comm.
Banks
17.5%
12.2%
17.5%
8.3%
1.1%
4.3%
2.1%
2.1%
5.7%
2.4%
5.2%
2.2%
3.3%
0.0%
28.3%
7.1%
0.7%
35.0%
4.1%
1.2%
31.7%
3.9%
0.9%
32.3%
Product Offerings at Community Banks
to Generate Noninterest Income
Percentage Offering Product
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
85.0%
Residential Mortgages*
73.0%
Debit cards
Credit Life
58.6%
Phone banking
54.6%
Online banking
52.7%
52.3%
ACH orgination
47.7%
Check image statements
Credit Cards
46.1%
Fee-based overdrafts
38.8%
Annuities
35.7%
33.9%
Mutual Funds
31.1%
Life insurance
SEP IRA
30.4%
Cash management
30.4%
28.3%
Personal trust
27.3%
Stock brokerage
401(k) plans
23.0%
Financial Planning
16.9%
P&C insurance, personal
13.0%
Courier service
12.0%
P&C insurance, buiness
11.8%
Title insurance
9.7%
Payroll processing
8.9%
Farm insurance
Online brokerage
7.7%
5.2%
RE brokerage/management
3.1%
Debt cancellation contracts
2.8%
Muni bond underwriting
Travel agency
90.0%
2.1%
1.9%
Strategies to Manage Non-Interest
Expense
 Cost Management Strategies
 Expense Reduction
 Operating Efficiencies
 Revenue Enhancement
Cost
Management Strategies
 Be careful not to just focus on reducing
Expense Reduction
costs, rather, move them in line with
strategic objectives.
 Begin by identifying excessive expenses
and eliminating them

Largest non-interest expenses are personnel,
occupancy, and data processing costs.
These are often the areas where cuts are
initially made.
 Outsourcing
Cost Management Strategies:
Operating Efficiencies
 Reducing costs while maintaining
existing level of products and services
 Increasing the level of output while
maintaining the level of current
expenses
 Improving work flow (doing things
faster)
 Operating efficiencies of:
 Economies
of Scale
 Economies of Scope
Cost
Management
Strategies:
 Price
Elasticity
Revenue
 Identify Enhancement
products or services that exhibit

price inelastic demand
Change the pricing of specific products while
maintaining a sufficiently high volume of
business so that total revenue increases
 Contribution Growth
 Management allocates resources to best
improve overall long-term profitability
 Increases in expenses are acceptable, but
they must coincide with greater anticipated
increases in associated revenues
 In the short-run, expenses rise, but
expenses are cut in the long-run
Bank Management, 6th edition.
Timothy W. Koch and S. Scott MacDonald
Copyright © 2006 by South-Western, a division of Thomson Learning
MANAGING
NONINTEREST INCOME &
NONINTEREST EXPENSE
Chapter 3
William Chittenden edited and updated the PowerPoint slides for this edition.