Profits and balance sheet developments at U.S. commercial banks in 1996 - includes related articles on consolidation of commercial banks, credit card banks

Federal Reserve Bulletin, June, 1997 by William R. Nelson, Ann L. Owen

Interest Income and Expense

Both interest income and interest expense as a percentage of assets fell slightly at commercial banks last year, reflecting the moderately lower market rates that prevailed, on average, in 1996 relative to 1995. The decline in expense exceeded the decline in income, leaving net interest income as a percentage of assets (the net interest margin) 3 basis points higher than in 1995 and, despite declines in 1994 and 1995, still elevated relative to the late 1980s.

The net interest margin was held down in the late 1980s by competition among banks for loans and funding sources. It surged in 1991 and 1992 as banks widened spreads between loan and deposit rates in an effort to improve capital ratios by boosting earnings and curbing asset growth (chart 11). The rise occurred even though loans, which tend to yield more than securities, declined as a share of assets.

[Chart 11 ILLUSTRATION OMITTED]

Since 1992, more aggressive loan pricing and greater reliance on managed liabilities have squeezed the net interest margin somewhat, but it remains high for several reasons. First, compared with the early 1990s, banks fund a significantly larger fraction of assets with capital, and the returns on capital are not considered an interest expense. Also, rates paid on retail deposits have been low relative to market rates. Finally, the margin has been held up significantly by a rebound in the share of assets in loans and a rising volume of loans to households, a relatively high yielding category of loans.

Noninterest Income and Expense

Noninterest income provided a hefty boost to return on assets last year, increasing 17 basis points as a percentage of assets relative to 1995. Over the past ten years, noninterest income has accounted for an expanding share of bank revenue (chart 12). A small part of the increase has been from fiduciary activities and trading revenue, but most of the growth has been in the broad category "other noninterest income," which includes merchant credit card fees, annual cardholder fees, fees for servicing mortgages, and income from loans that have been securitized. Thus, the increase in the proportion of revenue accounted for by noninterest income likely reflects both the expansion of bank lending to households and the growing fraction of bank loans that are securitized.

[Chart 12 ILLUSTRATION OMITTED]

Noninterest expense as a percentage of assets rose 8 basis points in 1996 even though occupancy and employee costs were about unchanged. The increase reflects a rise in "other noninterest expense" accounted for by two recent adjustments in deposit insurance premiums. In 1995, banks received a rebate of $1 1/2 billion for overpayment of deposit insurance, while in 1996, banks that had acquired thrift deposits paid a $1 1/4 billion one-time assessment to support the Savings Association Insurance Fund. Other noninterest expense was also boosted last year by higher merger restructuring charges, with the Chase Manhattan Corporation-Chemical Banking Corporation merger alone accounting for $1 3/4 billion in expenses. (See the accompanying box for a brief discussion of the continuing consolidation of the banking industry.)