How Do Banks Make Money?
Banks make a profit through lending money, collecting fees and more. Interest is a main source of profit, but many banks have other ways of making money.
March 28, 2022
There are more than 4,300 commercial banks in the United States, with a total of around 75,000 branches. And our banks are closely involved in many of our day-to-day activities, from receiving paychecks to buying groceries.
We depend on banks to keep our money safe. And often, we don’t pay banks directly for their services. Which prompts the question — how do banks make money?
This comprehensive guide will cover how banks make money through loans, interest, fees, investments and more.
How do banks make money?
The primary source of revenue for most banks is interest.
Banks are in the business of loaning out money — through auto loans, mortgages, personal loans and credit cards.
All of these loans charge interest. The bank loans out money, and customers pay back the loans over time, with interest.
Put simply, that means that if someone borrows $1,000, they may pay back $1,100 — resulting in a $100 profit for the bank.
Interest isn’t the only source of revenue for banks, however. These are the primary ways that banks make money:
Loaning out money and charging interest
Charging fees to bank customers
Interchange fees when customers use a debit or credit card
Earning commissions on partnerships and related services
Charging for advisory services
Let’s dive deeper into each of these revenue sources.
Banks profit from interest revenue on loans
Banks offer customers loans, including:
Banks charge interest on these loans. They use their own money to issue these loans, as well as the money that bank customers deposit into checking and savings accounts.
To understand this further, it’s helpful to think about how interest works.
There are two types of interest. The interest rate the bank:
Charges customers when they take out a loan
Pays depositors when they keep money in the bank
The interest rate “spread” is a term that describes the difference between these two rates of interest.
Banks will charge customers a higher rate of interest than the interest they pay depositors. The difference between the interest rates is the spread and the source of a bank’s profit.
For example, the bank may pay depositors 1% on their money, but charge a mortgage customer 5%. The 4% difference drives profit for the bank.
To further illustrate, consider this example:
You have $1,000 in your savings account at a local bank.
The account is interest-bearing and pays you 1% in interest.
You earn $10 per year in interest from the account.
The bank issues a mortgage loan for another customer.
The mortgage interest rate is 5%.
Your $1,000 is combined with deposits from many other accounts and used to back the mortgage loan.
The bank earns about $50 per year in interest payments from the $1,000 in your account and pays you $10 in interest.
This results in a profit of $40 per year for the bank.
This is a simplified example, but it illustrates the basic process behind how banks profit from interest charges.
Banks profit from fees charged to customers
Banks may charge a number of fees for their services, which creates revenue and profit for the bank.
These fees could include:
Monthly service fees ($5/month for a checking account, for example)
Loan origination fees ($200 fee to originate an auto loan, for example)
Overdraft fees ($35 if a customer spends more than they have available in their account)
Credit card annual fees
Late payment fees
Banks profit from interchange fees
Interchange fees are an automatic fee that is charged to merchants whenever someone makes a purchase using a debit or credit card.
For example, if you buy a coffee at your local cafe using your debit card, the coffee shop owner will be charged a very small fee to process the transaction. Part of the fee charged will go to your bank; some may also go to Visa, MasterCard or other third parties.
Interchange fees may be small, but they add up to contribute a significant amount to the income of many banks.
Banks may profit from investing and trading
Certain types of banks will also participate in investing and/or trading strategies to make money. They may invest in the stock market, in government bonds or even in local businesses.
Not all banks actively trade — but for those that do, this can be a significant source of revenue.
Banks may profit from advisory services
Many banks offer advisory services to their clients. For example, they may have an in-house financial advisor or wealth manager, who can help clients manage their money or investments.
Banks charge fees for these services. It could be a flat fee (like $200 per appointment), or a percentage fee (like 1% of the assets they help invest for you).
Similarly, banks may earn commissions from referring their clients to third-party advisors or services. For instance, a bank may be able to refer clients to a local insurance agent and may earn a commission if the client ends up buying insurance.
How do banks make money from free checking accounts?
If you have a free checking or savings account, you will pay no fees to your bank. In this case, how does the bank make any money?
Banks issue loans to other customers, using the money you deposit in your account. The bank will charge that customer a higher interest rate than the rate they pay you on your savings.
In this way, the bank can profit from having you as a customer, even if you don’t directly pay for any services or fees.
Mastering your money
Understanding how banks make money is a “behind the scenes” consideration when it comes to learning about personal finance. But it’s an important one — and it’s certainly interesting!
If you want to learn more about personal finance, The Score Blog from Tally is a great place to start. We have many useful resources on paying off debt, mastering credit and managing your money.
If you have credit card debt and want to pay it off, take a look at Tally†. Tally is a personal finance app for Americans with credit card debt. Tally may help qualifying applicants pay off their credit card debt faster while paying less in interest.
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