Direct Answer
Diversified banks earn primarily through net interest income (NII): the spread between interest earned on loans and securities and interest paid on deposits and borrowings. Net interest margin (NIM) is NII as a percentage of earning assets. Credit quality (loan loss provisions, NPL ratio, charge-off rate) is the primary risk variable; the efficiency ratio measures operating expense as a percentage of revenue.
Bank Revenue Model: NII, Fees, and Trading
Large diversified banks earn revenue from three primary sources. Net Interest Income (NII): the spread between yield earned on loans/securities and rate paid on deposits/borrowings. NIM (NII as a percentage of average earning assets) is the key efficiency metric. Rising interest rates generally expand NIM as loan yields reprice faster than deposit costs.
Non-interest income (fee revenue): service charges, card fees, investment banking fees, asset management fees, and trading revenue. Non-interest income diversifies revenue away from interest rate sensitivity and provides more stable earnings through rate cycles.
Trading revenue: at large investment-banking-oriented banks (JPMorgan, Goldman, Morgan Stanley), Fixed Income/Currency/Commodities (FICC) and equities trading contribute significant quarterly revenue but with higher volatility than traditional banking income.
Credit Quality: The Primary Risk Driver
Credit quality determines whether interest income translates to actual profit. Key metrics: Net Charge-Off (NCO) rate: loans written off as uncollectable minus recoveries, as a percentage of average loans. Non-Performing Loan (NPL) ratio: loans 90+ days past due or on non-accrual, as a percentage of total loans. Provision for Credit Losses (PCL): the current-quarter expense for expected future losses, which flows through the income statement and reduces earnings.
Under CECL (Current Expected Credit Loss, effective for large banks in 2020), banks must reserve for lifetime expected losses on new loans at origination, not just losses that are "probable" (the prior incurred-loss model). This front-loads credit costs and increases reserve volatility through economic cycles.
Allowance for Credit Losses (ACL) as a percentage of total loans is the balance sheet reserve buffer. Higher ACL ratios indicate more conservative reserving; release of excess reserves (when losses come in better than expected) creates a tailwind to earnings.
Regulatory Capital: Tier 1, CET1, and Basel III
Banks are required to maintain minimum capital ratios under Basel III. CET1 (Common Equity Tier 1) is the core measure: common equity minus goodwill and certain intangibles, divided by risk-weighted assets (RWA). Large US banks are required to maintain CET1 ratios of 7-13%+ depending on their Global Systemically Important Bank (G-SIB) surcharge and stress test results.
The Federal Reserve's annual stress tests (DFAST/CCAR) simulate severe economic scenarios and set bank-specific capital requirements. Banks that pass can return excess capital through buybacks and dividends; insufficient capital under stress scenarios requires capital retention plans.
Basel III Endgame (proposed in 2023, finalized with significant modifications) would increase RWA for market risk and operational risk at large banks, potentially requiring additional capital issuance or asset reduction to maintain ratios.
Major Players: JPMorgan Chase, BofA, Wells Fargo, Citigroup
JPMorgan Chase (JPM) is the largest US bank by assets (~$3.9 trillion), with leading positions in investment banking (consistently #1 or #2 globally), consumer banking (Chase), asset and wealth management, and commercial banking. Its scale, diversification, and management execution have produced consistently superior returns relative to peers.
Bank of America (BAC) has the largest US retail deposit franchise and significant wealth management (Merrill Lynch) and investment banking operations. Its deposit beta (sensitivity of deposit pricing to rate increases) is structurally lower than peers due to its large base of mass-market consumer accounts.
Wells Fargo (WFC) remains under an asset cap (total assets capped at $1.95 trillion by the Fed) stemming from its 2016 fake accounts scandal. The cap limits loan growth and is a key investor question mark about when it will be lifted.
Citigroup (C) is the most internationally diversified of the large US banks, with major operations in Mexico, Asia, and across global markets. Its ongoing transformation (simplification, exit from 14 consumer markets) has been a multi-year turnaround effort.
Investment Considerations: Rate Sensitivity and Regulatory Risk
Bank stocks are among the most rate-sensitive in the market. Rising rates expand NIM (asset yields reprice faster than deposit costs) until deposit betas catch up; falling rates compress NIM. The shape of the yield curve matters too: banks borrow short and lend long, so an inverted curve (short rates above long rates) compresses the lending spread.
Banks trade at price-to-tangible-book value (P/TBV) multiples, reflecting the equity capital base. Banks generating returns on tangible common equity (ROTCE) above cost of equity trade above 1x P/TBV; those earning below cost trade below. JPMorgan has consistently traded at 2x+ P/TBV due to superior ROTCE.
Regulatory risk is structural: changes to capital requirements, stress test methodology, fee regulations (overdraft, interchange), or enforcement actions can materially affect earnings. The 2023 regional banking crisis (SVB, Signature Bank, First Republic) accelerated regulatory review and increased scrutiny of unrealized securities losses and deposit concentration.
FAQ
What is net interest margin (NIM) in banking?
Net interest margin (NIM) is net interest income (interest earned on loans and securities minus interest paid on deposits and borrowings) divided by average earning assets. It is the primary measure of a bank's core lending profitability. A NIM of 3% means the bank earns 3 cents of net interest per dollar of earning assets. Rising interest rates generally expand NIM initially as loan yields reprice faster than deposit costs, until deposit betas (rate sensitivity) catch up, usually with a lag of 12-18 months.
What is the CET1 ratio and why does it matter?
The Common Equity Tier 1 (CET1) ratio is a bank's common equity (minus goodwill and intangibles) divided by risk-weighted assets (RWA). It is the primary regulatory capital measure under Basel III. Minimum requirements vary: most large US banks must maintain 7-13%+ CET1 depending on their G-SIB surcharge and stress test results. A higher CET1 ratio provides more buffer against losses and gives the Fed confidence to allow share buybacks and dividends, making it both a safety metric and a capital return gating factor.
What is CECL and how did it change bank accounting?
CECL (Current Expected Credit Loss, effective for large banks in 2020) replaced the incurred-loss model for loan loss reserves. Under the old model, banks only reserved for losses that were "probable and estimable." Under CECL, banks must estimate and reserve for lifetime expected losses on loans at origination, based on historical loss rates adjusted for current conditions and forecasts. CECL front-loads credit costs (larger initial reserves) and creates more volatility through cycles, as reserves must be updated as economic forecasts change, even before losses are actually realized.
Why is Wells Fargo under an asset cap?
The Federal Reserve imposed an asset cap on Wells Fargo in February 2018, limiting total assets to their end-of-2017 level ($1.95 trillion), as a consequence of the bank's systemic fake-accounts scandal in which employees opened millions of unauthorized consumer accounts to meet sales targets. The cap restricts Wells Fargo's ability to grow loans and is a unique competitive disadvantage relative to peers. The cap will only be lifted once the Fed determines that Wells Fargo has adequately remediated its risk management and governance failures, a process that had not been fully completed as of 2025.