Net Interest Income (NII) represents the difference between the interest earned from a financial entity's interest-earning assets and the interest paid on its interest-bearing liabilities. Interest-earning assets include loans provided to customers, mortgages, or other financial instruments from which an institution earns interest. In contrast, interest-bearing liabilities include deposits taken from customers or borrowings for which the institution needs to pay interest. For example, if a bank earns $10 million from its loans to customers and pays $4 million in interest to its deposit holders, its NII will be $6 million.
Understanding NII is crucial for financial institutions, as it forms part of their core income. Fluctuations in NII can result from interest rate changes, asset quality, and the institution's ability to manage its cost of funds. Effective management of NII helps banks optimize profitability and ensures sustainability amidst varying financial conditions. For instance, if a central bank increases the base interest rate, the NII may increase depending on the time it takes for the rate change to influence assets and liabilities. Terms like 'Net Income' and 'Interest Expense' are often evaluated alongside NII to assess financial performance comprehensively.