How do banks make money? 

Banks’ core means of money generation is lending money. Generally, banks borrow money from depositors in exchange for a promise of keeping it safe and a certain amount of interest rate on the amount deposited and lend the same money to the borrowers in exchange for a higher interest rate than they offer to depositors. Thus, it makes a profit from the difference in the interest rate. 

Different means of making money by banks:

The basic revenue structure of banks is based on lending money at higher interest rates to the borrowers in the name of a loan. 

Additionally, there are many alternative ways for banks to generate money. Some main means for a bank to make money are as follows:

‌Loans ‌Charging Penalties‌Banking Fees‌Capital Market 

1.Loans

As mentioned above, the primary way for banks to earn a profit is to lend money in the name of loans and mortgages. Banks make millions of dollars of profit by paying a small interest rate to depositors and asking for a much higher interest from borrowers and businesses. 

Example –

Assume, a person asks to open a fixed deposit (FD) for a certain amount period, which can be years. In exchange, the bank offers a 3% to 4% interest rate on the amount deposited annually to the person. On the other hand, a bank has access to that fund for a very long term which it will issue as a loan to a person or business at a 9% to 10% interest rate that is more than double that depositor gets. That’s how a bank’s primary revenue structure works, which tends to make them a lump sum amount of money. 

2. Charging Penalties

Mostly, all of us have gone through the experience of paying the penalties imposed by banks at some point. There are many rules and regulations stated by the banks which authorize them to charge penalties. Some significant reasons are –

‌Inactive Account

If the account holder is not using the account actively, which means the account tends to be dormant, then it can be penalized. 

‌Low Balance 

Some accounts have a certain minimum limit of money that has to be present in the account. If this is not the case then, due to a low balance, the bank imposes charges on the account holder. 

‌Check Penalties

 If the check is bounced, which means the account holder doesn’t have enough money in the account can cover the amount on the check, then there is a heavy penalty on the check issuer as well as the check depositor.

‌Dues

Banks also make money from charging penalties on the dues. There are several types of dues. Generally, it happens with credit card holders when there is a due monthly bill, the bank charges them extra money to compensate for the consequences. 

‌Overdraft Fee

If one doesn’t have overdraft protection and pays a bill through a card and does not have enough money in the account required to pay then the payment will be successful but can be a reason for the overdraft fee. 

3. Banking Fees

A banking fee is also an extensive way to earn money for banks. Banks charge banking fees in several forms. Some of them are as follows –

‌Service Fee

Banks earn a good amount of money through service fees or account maintenance fees. That is the fee that is important to pay to keep the account open. 

‌ATM Fees

When you use another bank’s ATM to withdraw money using your bank’s ATM card then both the banks will impose a certain amount of charge. This is also an add-on to the revenue of banks. 

‌Transaction Fee 

There is a certain amount of money charged by the banks to the merchant where you pay using your debit card or credit card. This is the motive, the merchant asks for cash. Although, nowadays the government has removed this fee from many places. 

 4. Capital Market

Banks have diversified ways of making money and one of them is through capital markets. Banks also offer many other services other than just borrowing and lending money. Banks provide services to large companies and investors in the capital market like sales, trading services, M&A advisory, etc. It also provides funds for large projects. 

This source of income depends on the active situation of the capital markets. Hence, this is a volatile source of income. It may be a good income generator and vice versa depending on the period and situation of the market. Thus, banks earn a fluctuating amount of money from this. 

Other than these major four sources, banks have several other sources of income too, like mutual funds, custodian fees, management fees, etc. 

Conclusion :

Although, we use the bank services almost daily thinking that they are the least profitable. But on the contrary, banks are commercial businesses that make millions and billions of dollars of profit with the help of very small margins but to a large extent, these small margins make a huge difference. Banks have a very good, old-fashioned but updated structure to make money and earn profit.