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April 2023

How Do Banks Make Money?

Coins pouring from jar symbolize banks' money-making process.
Last updated June 14th, 2024

How Do Banks Make Money?

If we think only in terms of the savings and checking accounts they facilitate, it’s easy to wonder, how do banks make money? They must generate enough income to operate, profit, and grow. And that’s a good thing, because consumers can benefit from the services financial institutions provide.

Revenue creation in the commercial banking industry involves many different methods and sources of income. Banks make money mainly from interest income, service fees, and trading and investments. These provide income streams that let financial institutions remain solvent and offer valuable services to their customers.

In this article, we’ll delve into how banks generate revenue to stay profitable, competitive, and in business.

Interest paid and received

The typical banking institution offers several types of deposit accounts and financial products on which they pay interest to customers. These include savings accounts, certificates of deposit, IRAs, and checking accounts. These pay interest, so the bank’s customers earn money on their deposits and investments. (However, not all checking accounts pay interest.)

Account interest rates might be 0.2% for a simple savings account, or as much as 4%-5% for high-yield accounts. The interest rate depends on account balances, lengths of deposit, type of account, and other factors.

But if banks, credit unions, and other financial institutions are paying out money, how does that generate income for them?

The more deposits and investments they attract, the more money banks have for lending to customers and other banks. People borrow money every day in the form of personal loans, auto loans, home mortgages, credit cards, business loans, and home-improvement and remodeling loans. And when they lend money, banks charge higher interest than what they pay to depositors. For an auto loan, most banks might charge an interest rate of 6% to 20%. That’s a much higher rate than the 0.2% for a savings account, for example.

Service fees

A range of bank fees exist to help generate income as well. Traditional banks have a fairly standard set of account fees (their fee schedule) on deposit accounts and other banking services. To minimize your banking costs, it’s good to know what, when, and why your bank charges fees and penalties.

Deposit accounts

Deposit accounts often involve such banking fees as:

  • Monthly account fees, including maintenance fees and charges for not keeping the minimum balance.
  • Overdraft fees for protection when a checking account’s balance doesn’t cover a check or charge/payment.
  • Withdrawal fees for bank accounts that place limits on the number of withdrawals per cycle or total amount of money.
  • Fund and wire transfer fees for transfering money to another person or bank.
  • ATM fees for withdrawing your own money via a bank or credit union’s automated teller machine.

Loan accounts

Loans and lines of credit, which include credit cards, are important drivers of consumer spending by individuals, small businesses, and larger companies. In addition to interest charged, they may include such fees as:

  • Application fees, for applying for a loan.
  • Credit-check fees, running a credit check on applicant(s).
  • Appraisal fees. These typically apply to mortgages and home-equity loans and lines of credit, to establish a home’s value.
  • Origination fees, for loan completion and for dispersing funds.
  • Late payment fees, for missing a payment date.
  • Early payoff fees, for paying off a loan before its contracted maturity date.

The fees charged throughout the banking system add up when you consider how many customers are paying them. One report found that the average bank generated 1.3% of its operating budgets from service charges and fees.

Trading and investment income

In the field of investment banking, banks engage in trading and investing. Instead of lending their assets, banks might invest that money in stocks, bonds, or mutual funds. If and when the investments are successful, the bank earns a profit.

Investment banks differ from the usual hometown banks. They focus on financial products for corporate and institutional customers, and may offer one or more of these services:

  • Underwriting. The bank buys shares or bonds from a business trying to raise funds. Later, they’ll try to sell the securities at a profit. This often happens through a syndicate of banks working together to share risk and increase sales potential.
  • Financial advice. Banks advise startups, often about raising funds, and established companies, typically regarding sales of stock or debt notes.
  • Managing mergers and acquisitions. Banks research the value of a company targeted for purchase and offer risk-management strategies. Sometimes they negotiate prices.
  • Initial public offerings. In helping companies to go public, banks set the initial price of the stock, promote the offering, and manage sales.
  • Wealth management services. Many banks and financial institutions earn money from services pertaining to customers’ investments, investment accounts, and wealth management. Some investment banks specifically cater to wealthy clients. Banks help clients manage assets, give advice on investments, and propose tax shelter strategies. Fees may include any combination of flat fees, rates and commissions for brokerage services.
  • Asset management. Banks help select investment vehicles (trusts, stocks, bonds, etc.) to meet the client’s goals.
  • Trading services. Many big investment banks have in-house trading departments to buy and sell stocks and bonds on customers’ behalf.

So, how do banks make money over time?

Banks earn money through a variety of methods so they have a diversified stream of corporate revenue. And that enables banks to remain profitable, solvent, and agile in providing valuable services to their customers.

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