How do banks make money?

Client and bank employee talking by counterImage: Client and bank employee talking by counter

In a Nutshell

The interest and fees that banks earn on loans is a major source of income. But many banks also have non-interest ways of making money.
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One of the many purposes of banks is to give people and businesses a way to store funds and access credit. But a lot of financial institutions also focus on profits and making money from the same customers they’re serving.

Understanding how banks make money can help you decide what to look for in a new bank.

How do banks make money?

The ways that traditional banks make money can vary depending on the type of bank and its target customers.  

Community banks primarily make money from the interest they earn lending money to local residents and small businesses. The money comes from depositor funds held in several types of bank accounts. While many large banks also make most of their income from interest, they earn a larger share of their revenue from non-interest sources than community banks do.

Large banks are also often made up of different divisions that focus on various types of customers and services. For example, their commercial banking or retail banking divisions may offer traditional bank services, such as deposit accounts (like checking or savings) and issue personal and business loans. However, their investment banking divisions may help large corporate and government clients raise money, manage their money and invest the bank’s money.

How banks make money with interest

Many banks make the majority of their money from charging interest on loaned funds, such as home loans, auto loans or personal loans that are issued to consumers. Many banks also offer loans to small and large businesses. Customers who have a credit card and revolve a balance may also pay interest on their credit card debt.

How banks make money with fees

Banks can also make a lot of money on banking fees. These can range widely depending on the type of account or service you have with the bank, and may include …

  • Bank account fees — Banks may charge you a monthly maintenance fee for having a checking or savings account. You may also have to pay fees to use bank-related services, such as withdrawing money from a non-bank ATM, to make transactions with your credit or debit card in countries outside the U.S. or to receive a money order or cashier’s check. There may also be account-related fees for bill payment services, or for overdrafts and nonsufficient funds in your account.
  • Credit card feesCardholders may pay an annual fee to open and use the bank’s credit cards. Usage-based fees — for cash advances, balance transfers, late payments or exceeding the credit limit — are also common. In addition to late fees, making a payment 60 days or more after it’s due could lead to a penalty annual percentage rate (or APR).
  • Loan and service fees — Banks may also collect fees when they issue loans or sell other financial products, such as an insurance policy. Some banks will issue loans and then sell the loan to another financial institution instead of collecting interest from the borrower. The bank may still make money on the loan origination fee and sale, or could collect fees to service the loan.
  • Investment fees — Banks that offer investment services can also earn fees for managing clients’ investments and brokerage services (a fee each time you buy or sell a stock, for example). Banks that create or sell mutual funds, annuities and other financial products may also earn commissions or fees from these sales.

How banks make money with interchange fees

Banks can also make money whenever you use the bank’s debit card or credit card to make a purchase. Merchants pay what’s called a merchant discount fee when they accept a card. With cards that are issued by banks (such as Visa and Mastercard credit and debit cards), a portion of the discount fee goes to the issuing bank. This is called an interchange fee.

Some banks also offer merchant accounts to businesses that want to accept debit and credit cards. They can then collect merchant processing fees from the merchant on its card-based sales.

Other ways banks make money

Banks have other ways of earning non-interest income.

  • Investments — In addition to earning fees and commissions on customers’ investments, banks may be able to invest their own money.
  • Advisory services — Some banks also make money by acting as an adviser for other businesses. They may sell research or investment ideas to individuals and businesses. Entities may also hire the bank to help with raising money, public offerings, and mergers and acquisitions.
  • Commissions — Banks may have partnerships with insurance agents, brokerages, investment services and other businesses that pay them a commission to refer customers.

Next steps: Ways to reduce your banking costs

While you may benefit from the services that banks offer, you can also look for ways to save money by minimizing your banking costs.

  • Look for fee-free banking services. If you want a basic checking or savings account, look for banks that don’t have minimum balance or monthly service fee requirements. Remember, though, that even with a fee-free checking account, there can be other fees — including ATM fees charged by third-party providers.
  • Don’t opt in for overdraft services. Accepting your bank or credit union’s overdraft services can lead to overdraft fees. Instead, aim to keep an eye on your balance and balance your checkbook regularly to avoid nonsufficient funds fees.
  • Understand what you’re getting for your fees. Paying a fee for a service or product isn’t a bad idea if you feel the benefits outweigh the costs. For example, credit card annual fees may be worth it if benefits from perks and rewards make up for it. But there are also many rewards cards, including travel cards, that don’t have annual fees
  • Beware of sales tactics. You may think of bank tellers as helpful customer service representatives. However, at some banks, they serve a dual function and are expected to act as salespeople as well. Tellers may try to get you to open other accounts at the bank to meet their sales quotas (remember the Wells Fargo fake account scandal). Banks can also earn commissions or collect fees when you buy investments or insurance products from the bank. If your financial adviser works for a bank, beware of the potential conflict of interest that may arise, particularly if your adviser works on commission.
  • Comparison shop when applying for a loan. One of your biggest banking costs may be the fees and interest you pay on a loan, especially if you’re taking out an auto loan or mortgage. However, you can comparison shop when looking for a lender — you don’t have to borrow money from your current bank.

Shopping for a loan won’t necessarily hurt your credit, and you don’t need to accept a loan offer when you’re approved. Comparing offers from several lenders can help you find a loan with the lowest possible fees and interest rates. 

In general, the less you spend on banking fees or penalties, the more money you’ll have to pay off debt, build savings and invest for your future. While banks might also earn money by offering these services, you’ll both be benefitting in the long run.

About the author: Louis DeNicola is a personal finance writer and has written for American Express, Discover and Nova Credit. In addition to being a contributing writer at Credit Karma, you can find his work on Business Insider, Cheapi… Read more.