How Do Banks Make Money? (2024)

Different ways for banks to earn money

Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets.

Start Free

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? (1)

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:

  1. Interest income
  2. Capital markets income
  3. Fee-based income

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 borrowers 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.

Importance of Interest Rates

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 of 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 paying depositors a low interest rate and being able to charge borrowers a higher interest rate. However, banks need to manage credit risk, which is the potential of a borrower to default on their loans.

In general, banks benefit from an economic environment where interest rates are falling. When rates are low, banks pay their depositors lower rates but loans are still lent out with a significant spread. Additionally, when rates are low, there is more incentive for companies and individuals to borrow, increasing the demand for loans. The opposite also holds true. When rates are high, loan demand tends to fall as loan are more expensive and the economy tends to be at a stronger point of the economic cycle – meaning that companies should be doing well and not needed as much financing. It also means that depositors might shift from other investments towards bank deposits, which then squeezes a bank’s interest margin.

Capital Markets-Related Income

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:

  • Sales and trading services
  • Underwriting services
  • M&A advisory

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.

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:

  • Credit card fees
  • Checking accounts
  • Savings accounts
  • Mutual fund revenue
  • Investment management fees
  • Custodian fees

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 to 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.

Additional Resources

Thank you for reading CFI’s guide to How Do Banks Make Money. To keep learning and advancing your career, the following resources will be helpful:

  • Free Introduction to Banking Course
  • Credit Risk
  • Checking Accounts vs. Savings Accounts
  • Net Interest Rate Spread
  • Private Wealth Management
  • See all economics resources
How Do Banks Make Money? (2024)

FAQs

How Do Banks Make Money? ›

Banks make their money through various fees, interest, and investments, but the main source of revenue for private banks comes from lending out excess reserves to other customers. Banks help to connect savers and borrowers.

How exactly do banks make money? ›

They earn interest on the securities they hold. They earn fees for customer services, such as checking accounts, financial counseling, loan servicing and the sales of other financial products (e.g., insurance and mutual funds).

What is the main way that banks earn money? ›

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.

How do banks make their money Quizlet? ›

How do banks make money? Banks borrow money from people and pay them annual interest. With that borrowed money, the banks lend it out to people and receive annual interest. That loan interest should be higher than the borrowing interest.

How do banks create money? ›

Banks create money when they lend the rest of the money depositors give them. This money can be used to purchase goods and services and can find its way back into the banking system as a deposit in another bank, which then can lend a fraction of it.

Do banks pay a lot of money? ›

Competitive salaries.

Bank jobs generally come with good compensation. With a banking job, you can be sure of a steady source of income with high salaries. Depending on the job, you can earn upward of $30,000 in an entry-level role. Many higher-level jobs provide salaries of over $150,000.

How do free banks make money? ›

Any type of loan comes with interest, and this is how the bank makes its revenue. The amount of interest that the bank gets from their loans will always be greater than the interest that is paid back to you for keeping money in your checking account.

Who do banks borrow money from? ›

Banks can borrow at the discount rate from the Federal Reserve to meet reserve requirements. The Fed charges banks the discount rate, commonly higher than the rate that banks charge each other.

What do banks do to money? ›

Although banks do many things, their primary role is to take in funds—called deposits—from those with money, pool them, and lend them to those who need funds. Banks are intermediaries between depositors (who lend money to the bank) and borrowers (to whom the bank lends money).

What do banks do with most of your money? ›

It doesn't remain locked away in the bank vault – instead, the money you deposit into a savings account is used by the bank to make loans to other people and businesses in your community so that they have the money to pay for big expenses like houses and cars, or even to operate a business.

What are three ways banks make money in Ramsey? ›

Expert-Verified Answer
  • Interest on Loans: Banks profit primarily from the interest they charge on loans. ...
  • Fees and Charges: Banks impose a range of fees and charges on customers to generate revenue. ...
  • Investment Banking: Many banks offer investment banking services to high-net-worth individuals and corporations.
Mar 16, 2023

What do banks do with your money how do they make money doing this? ›

Fractional Reserve

One of the main ways that banks earn profits is through lending and, because depositors rarely remove the entire amount in their accounts at once, the bank is allowed to lend out most of the money they have collected in the form of deposits.

How does a bank make most of its profit on its business quizlet? ›

How does a bank make most of its profit on its business? By paying out less in interest on deposits than it earns in interest on loans. They are available whenever the account holder wants them. fees charged for ATMs and checking accounts.

Can you imagine a world without money? ›

A world without money will require an extremely ideal approach as when people are stripped of the incentives of activity, they choose to not participate in the activity. If workers receive no rewards, they will not work. But this will not eradicate any of the human needs crucial to the survival of humanity.

How strong is my bank? ›

You can look to see the amount of total deposits that a bank has and look to see whether they have been increasing over time. A strong track record of stable growth is an indicator of consumer confidence and the bank's ability to strengthen its balance sheet.

Do banks lend more money than they have? ›

Thanks to the U.S. fractional reserve banking system, commercial banks can lend out much of their cash deposits, keeping only a fraction as reserves.

How do banks create money from a $1 000 deposit? ›

Every time a dollar is deposited into a bank account, a bank's total reserves increases. The bank will keep some of it on hand as required reserves, but it will loan the excess reserves out. When that loan is made, it increases the money supply. This is how banks “create” money and increase the money supply.

How do banks make money off of the credit they issue? ›

The primary way that banks make money is interest from credit card accounts. When a cardholder fails to repay their entire balance in a given month, interest fees are charged to the account.

How much do owners of banks make? ›

How Much Do Bank Owner Jobs Pay per Year? $26,500 is the 25th percentile. Salaries below this are outliers. $125,000 is the 75th percentile.

Do banks make money when you use your debit card? ›

The second is payments. So every time you swipe your debit card, you're issuing bank is making money and their other payment services they provide. And the third leg are fees. So overdraft fees, account fees, wire fees, et cetera.

References

Top Articles
Latest Posts
Recommended Articles
Article information

Author: Rubie Ullrich

Last Updated:

Views: 6049

Rating: 4.1 / 5 (52 voted)

Reviews: 91% of readers found this page helpful

Author information

Name: Rubie Ullrich

Birthday: 1998-02-02

Address: 743 Stoltenberg Center, Genovevaville, NJ 59925-3119

Phone: +2202978377583

Job: Administration Engineer

Hobby: Surfing, Sailing, Listening to music, Web surfing, Kitesurfing, Geocaching, Backpacking

Introduction: My name is Rubie Ullrich, I am a enthusiastic, perfect, tender, vivacious, talented, famous, delightful person who loves writing and wants to share my knowledge and understanding with you.