Why are changes in gross interest income and gross interest expense highly correlated, while noninterest income...

Why are changes in gross interest income and gross interest expense highly correlated, while noninterest income and noninterest expense are less highly correlated?

Expert Solution

Gross interest income (typically of a bank or financial institution) is the interest earned on the funded assets like loans, mortgages, investments in debt instruments etc. On the other hand, gross interest expense is the total interest paid on the liabilities like deposits and borrowings. Liabilities form the raw material for the bank or financial institution for its core activities viz. lending and investments. As a result, volume of financial assets is dependent on the size of financial liabilities- both are directly proportional. Both the interest earned and interest expended form variable income and expense.

Interest rate on both the financial assets and liabilities have a common factor in the form of interest rate in the economy. This, in turn, comprise of the real rate as well as inflation.

For the above reasons, gross interest income and gross interest expense are highly correlated.

Non interest income is the remuneration received for non funded activities like issue of guarantees, Letters of Credit, services rendered etc. Non interest expenses comprise of salaries and wages, rent, other expenses for infrastructure etc which are not fully based on the funds mobilized or deployed. Some of such expenses are in the nature of fixed costs. Moreover, the common factor viz. interest in the economy is is not applicable for non-interest income and expenses. Therefore, these are less correlated.

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explain Explain the process of Managing Noninterest Income and Noninterest Expense with financial institutions.

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