How Banks Make Money - ZEROX 24 Make Money

How Banks Make Money. How Banks Create Money. how do banks earn profit — Banks make money from service charges and fees. Many loan products also contain fees in addition to interest charges. Banks also earn money from interest they earn by lending out money to other clients.

Ever wonder how banks make their money? They can’t be offering to store your money for free? You’re right; here’s how banks earn money.

Diversified banks make money in a variety of different ways. However, at the core, banks are considered lenders.

Banks generally make money by borrowing money from depositors and compensating them with a certain interest rate.

The banks will lend the money out to borrowers, charging the borrowers a higher interest rate, and profiting off the interest rate spread.

How Do Banks Make Money Exactly?

Banks make money by charging penalties or recurring fees to account holders. However, the main way they make money is through loans.

Additionally, banks usually diversify their business mixes and generate money through alternative financial services.

Including investment banking and wealth management. However, broadly speaking, the money-generating business of banks can be broken down into the following:

Interest income
Fee-based income
Capital markets income

Below are the main ways in which banks make money.

Different Ways For Banks To Earn Money

1. Importance of Interest Rates For Banks To Make Money

Clearly, you can see that the interest rate is important to a bank as a primary revenue driver.

The interest rate is an amount owed as a percentage on a principal amount (the amount borrowed or deposited). In the short term, the interest rate is set by central banks that regulate the level of interest rates to promote a healthy economy and control inflation.

In the long term, interest rates are set by supply and demand pressures. A high demand for long-term maturity debt instruments will lead to a higher price and lower interest rates.

Conversely, a low demand for long-term maturity debt instruments will lead to a lower price and higher interest rates.

Banks benefit by being able to pay depositors a low interest rate, and also being able to charge lenders a higher interest rate.

2. Interest Income

Interest income is the primary way that most commercial banks make money.

As mentioned earlier, it is completed by taking money from depositors who do not need their money now.

In return for depositing their money, depositors are compensated with a certain interest rate and security for their funds.

Then, the bank can lend out the deposited funds to borrowers who need the money at the moment. The lenders need to repay the borrowed funds at a higher interest rate than what is paid to depositors.

The bank is able to profit from the interest rate spread, which is the difference between interest paid and interest received.

3. Capital Markets Related Income: How Banks Make Money

Banks often provide capital markets services for corporations and investors.

The capital markets are essentially a marketplace that matches businesses that need capital. To fund growth or projects with investors with the capital and require a return on their capital.

Banks facilitate capital markets activities with several services, such as:

M&A advisory
Underwriting services
Sales and trading services

Banks will help execute trades with their own in-house brokerage services.

Furthermore, banks will employ dedicated investment banking teams across sectors to assist with debt and equity underwriting.

It is essentially assisting with raising debt and equity for corporations or other entities. The investment banking teams will also assist with mergers & acquisitions (M&A) between companies.

The services are provided in exchange for fees from clients.

Capital markets related income is a very volatile source of income for banks. They are purely dependent on the capital markets activity in any given time period, which may fluctuate significantly.

Activity will generally slow down in periods of economic recession and pick up in periods of economic expansion.

4. Fee-Based Income

Banks also charge non-interest fees for their services.

For example, if a depositor opens a bank account, the bank may charge monthly account fees for keeping the account open.

Banks also charge fees for various other services and products that they provide.

Some examples are:

Since banks often provide wealth management services for their customers. They are able to profit off of the fees for services provided. As well as fees for certain investment products such as mutual funds.

Banks may offer in-house mutual fund services, which they direct their customers’ investments towards.

Fee-based income sources are very attractive for banks since they are relatively stable over time and do not fluctuate.

It is beneficial, especially during economic downturns, where interest rates may be artificially low, and capital markets activity slows down.

How Banks Make Money- Fees, Fees, Fees

Application Fees

Whenever a prospective borrower applies for a loan (especially a home loan) many banks charge a loan origination or application fee.

And, they can take the liberty of including this fee amount into the principal of your loan—which means you’ll pay interest on it too!

(So if your loan application fee is $100 and your bank rolls it into a 30-year mortgage at 5% APR, you’ll pay $94.40 in interest just on the $100 fee).

Account Fees

Some typical financial products that charge fees are checking accounts, investment accounts, and credit cards.

These fees are said to be for “maintenances purposes” even though maintaining these accounts costs banks relatively little.

ATM Fees

There will be times when you can’t find your bank’s ATM and you must settle for another ATM just to get some cash.

Well, that’s probably going to cost you $3. Such situations happen all the time and just mean more money for banks.

Commissions

Most banks will have investment divisions that often function as full-service brokerages. Of course, their commission fees for making trades are higher than most discount brokers.

Inactivity Fees

If your account goes inactive, also known as “dormant,” it will begin to accrue fees.

You can avoid this simply by making a deposit or withdraw, so there is activity on your account. Be sure to look into this before opening an account you plan to seldom use.

Penalty Charges

Banks love to slap on a penalty fee for something a customer’s mishaps. It could a credit card payment that you sent in at 5:05PM.

It could be a check written for an amount that was one penny over what you had in your checking account.

Whatever it may be, expect to pay a late fee or a notorious overdraft fee or between $25 and $40. It sucks for customers, but the banks are having a blast.

Wire Transfer Fees

You can use wire transfers if you want to send money to another bank or entity quickly.

These transfers typically happen on the same day. It is not the same as ACH transfers which can take a few days etc.

Fees depend on if the transfer is domestic or international and also vary depending on the financial institution.

Charges For Paper Statements

Some banks may charge for paper statements.

Also, if you need to request archived statements, this can mean additional fees as well.

Going paperless is more environmentally friendly, easier to track, and efficient anyway, so definitely consider this option.

Minimum Balance Charges

Minimum balance charges are another way how banks make money.

So if your account balance falls below the minimum balance, then they will charge you a penalty fee.

It’s best to find accounts that have zero minimum balances. So you have one less thing to worry about and pay for unexpectedly.

Recently, banks are taking a lot of heat for interest rate hikes and fees going out of control.

Giving banks business may seem like putting yourself in harm’s way. But of course, it still beats hiding your money under a mattress.

Understand how banks work. However, and you’ll know where to lookout for fees and how to avoid lining banks’ pockets by paying more interest than you’re earning.