Net Interest Income Simulation
Net interest income simulation goes beyond the static rate shock tables in SEC filings. Instead of asking "what happens if rates jump 200 basis points today," simulation asks "what happens to NII over the next one to three years under a specific rate path, given our expected loan growth, deposit trends, and pricing strategy?"
Static vs. Dynamic Approaches
Static models freeze the balance sheet at a point in time and shock rates. They're useful as a snapshot but miss important real-world dynamics: loans mature and get replaced with new ones at different rates, deposits flow in and out, and the bank changes its pricing in response to competition.
Dynamic simulation models all of that. They project a future balance sheet month by month, applying assumed loan origination volumes, deposit growth rates, prepayment speeds, and pricing spreads. The rate path itself can follow a specific trajectory (Fed raises rates 25bp per quarter for two years) rather than an instantaneous shock.
What Investors Can Learn
Banks occasionally share simulation results in investor presentations or earnings call commentary, though the detail varies widely. Statements like "we expect NIM to expand 5 to 10 basis points over the next four quarters assuming the forward curve" are outputs of NII simulation models.
Pay attention to the assumptions behind those projections. A bank forecasting NIM expansion because it expects deposit betas to remain low may be disappointed if competition for deposits intensifies. The projection is only as reliable as its inputs.
Key Assumptions That Drive Results
Four assumptions dominate NII simulation outcomes:
- Deposit betas: how much of a rate increase gets passed through to depositors. A bank assuming a 40% beta will project very different results than one assuming 60%.
- Prepayment speeds: how quickly borrowers refinance or pay down loans when rates fall. Faster prepayments mean the bank must reinvest at lower yields sooner.
- Balance sheet growth: whether the bank expects loans and deposits to grow, shrink, or stay flat. Growth in a rising rate environment can offset margin compression.
- Pricing spreads on new business: the margin the bank expects to earn on new loans relative to its funding cost. Competitive pressure can narrow these spreads regardless of where base rates sit.
Connecting Simulation to Valuation
For investors building earnings models, NII simulation results (when available) provide a useful reality check. If your model assumes a bank's NIM will hold steady but the bank's own simulation projects compression, there's a disconnect worth investigating. Management teams that provide clear forward NII guidance, and then deliver on it, tend to be managing rate risk effectively.
Related Articles
- Rate Sensitivity Modeling for Banks — Static sensitivity tables provide the starting point for dynamic simulation
- Asset-Liability Management in Banking — ALM committees use simulation results to set rate positioning strategy
Related Metrics
- Net Interest Margin (NIM) — NII simulation projects the path of net interest margin over time
- Cost of Deposits — Deposit beta assumptions are a critical input to NII simulation
- Cost of Funds — Overall funding cost trajectory is a primary simulation output