Banking is an integral part of our lives, and most of us rarely question where or how banks get their money.
The reality is that modern banking relies on a complex business model where revenue comes from many different sources – from interest income to fees to investment activities.
Understanding the various ways in which banks generate revenue can help anyone get a clearer picture of the current financial system and its impact on our day-to-day lives.
How Do Banks Make Most of Their Money?
Banks make money by borrowing and lending money. They profit on the basis of what is called the spread or the difference between the interest rate they impose on borrowers and the one they pay to depositors.
In addition, banks generate revenue through various avenues, such as service fees from investment banking, asset management, and trust services.
Furthermore, banks earn money off ATM charges and credit card annual fees too. To make it easier to understand, we’ve summarized everything on how banks make money into three categories:
- Interest income or the difference between what a bank pays for deposits and what it earns from loans. It’s the most important source of revenue for banks.
- Capital markets income or by matching businesses in need of capital resources to expand or fund their operations with investors willing to supply the necessary funds. The outcome is that businesses gain funds while investors get a return on their capital.
- Fee-based or non-interest income is for all the financial services banks offer; from credit card fees, checking accounts, and savings accounts to mutual fund revenue and investment management fees and more.
How do banks make money on savings accounts?
Most banks earn money on savings accounts by charging customers a fee for maintaining their accounts and by investing the funds deposited in the account. They typically take a portion of the deposits and use it to lend out to borrowers and keep some in reserve as mandated by regulations.
The interest earned from those loans is then used to pay depositors interest for keeping their money with the bank. Even though the rates paid to depositors are generally low, banks can still make a sizable profit off savings accounts by leveraging the deposited funds and collecting interest on the loans.
How do banks money from checking accounts?
Banks get money from checking accounts through service fees, such as overdraft charges and maintenance fees. Checking account customers typically have to pay a certain fee every month in order to keep the account open and operational.
Banks will also charge an additional fee if a customer exceeds their allowed number of transactions or writes too many checks. Furthermore, they can make money through interchange fees, which are charged when customers use their debit cards to buy goods or services.
How do banks make money on credit cards?
An annual fee and interest on the amount borrowed is how a bank earns money on credit cards. The annual fee can range from a few dollars to hundreds of dollars per year, depending on the type of card.
Merchants, for example, pay a fee for accepting card payments. One portion of this goes to the bank, and the other goes to the credit card company that issued the card (like Visa or Mastercard).
Note that credit card processing fees include interchange, payment, and assessment fees, but this is how credit card companies make money, not banks. Typically, the average credit card processing fee is between 1.5% and 3.5%.
How do banks make money from debit cards?
Banks charge a monthly maintenance fee or service fee to debit card holders for utilizing a checking or savings account. It’s a fee that’s automatically withdrawn from one’s bank account on a monthly basis. It’s how banks make money from debit cards.
However, a lot of banks provide the option to waive this fee if the debit card holder meets certain requirements. This may require the user to have a minimum balance on their account or register for another service like opening up a savings account or other.
How do banks make money from loans?
Banks earn money from loans by collecting interest on the amount borrowed. Banks typically take a portion of the loan and use it to lend to borrowers, while keeping some in reserve as mandated by regulations.
One portion of the interest earned from loans is then used to pay back depositors, and the other is how banks make money. As of March 2023, the average personal loan interest rate in the US is 10.71%. Banks also charge origination fees when customers take out a loan and late fees if a payment is not received by the due date.
How do banks make money on mortgages?
Banks make money on mortgages by charging interest. The interest rate charged depends on many factors, including the type of mortgage, the term of the mortgage, the creditworthiness of the borrower, and prevailing market rates. For most borrowers, the interest rate is the single biggest cost associated with their mortgage.
As of March 2023, the average interest rate for a 30-year fixed mortgage stands at 7.13%, and according to statistics, over 60% of US homeowners have mortgages. The interest rates banks charge on mortgages are also one of their biggest revenue streams.
How do banks make money from ATMs?
Banks typically charge fees for using ATMs that are not part of their network. These fees can be charged per transaction or as a monthly service fee. In some cases, banks may also charge customers for making withdrawals from foreign ATMs.
The fees charged by banks for using ATMs vary depending on the bank and the type of account you have. Typically, banks charge ATM users who are not their clients between $1.50 to $3.50 for using their ATM, but ATM operators may charge significantly more or as much as $10 per transaction.
Where do banks get money to lend to borrowers?
Banks get money to lend to borrowers from two main sources: deposits and borrowing. Banks collect deposits from checking and savings accounts, and other similar accounts. These deposits form the basis for banks’ lending activities.
But banks also borrow from other financial institutions in order to increase their supply of funds. This borrowing is generally done in the form of short-term loans. Banks use both deposits and borrowing to fund their lending activities, which include mortgages, business loans, auto loans, and more.
The Summary
Whether it’s by providing credit or loans, banks are an integral part of the economy, and a necessity for many people. Banks make money by collecting interest and fees on their various services, such as mortgages, ATM transactions, and savings accounts. They also get money to lend out by collecting deposits from customers and borrowing from other financial institutions. By engaging in these activities, banks can generate profits that they can use to expand their operations or reward their shareholders.