Aside from being considered a lender, a bank is also considered a financial institution that makes money by providing loans and compensating depositors with a certain interest rate.
This method of making money allows the banks to charge higher interest rates to the borrowers and profit from the spread. It can also diversify its business mix by acquiring other financial services such as wealth management and investment banking.
Ways That Banks Make Money
1. Interest Income
The primary method by which banks make money is through interest income. This process involves taking money from customers who do not need their money immediately and then compensating them with a certain interest rate. According to the experts at SoFi, “Credit card interest racks up when you don’t pay off your statement balance in full each month.”
Through this process, the bank can provide loans to its customers who need money immediately. The higher the interest rate that the bank charges, the better the chance that the borrowers will repay the loan at a higher rate.
Banks will charge customers interest when they don’t pay their balances in full each month. The balance left over after payment is made will be subjected to interest charges.
2. Capital Markets-Related Income
Capital markets are a type of marketplace that enables companies to raise capital. Activities banks facilitate to bring this type of income include underwriting services, sales and trading services and M&A advisory services.
Banks can help their clients make money through the execution of trades. In addition to these, they may also provide investment banking services to companies. This division is also involved in the raising of debt and equity for various entities.
The volatility of the capital markets is a major concern for banks. They are constantly dependent on the activities of the capital markets, which can change significantly. During times of economic recession, the activity in the markets tends to slow down. On the other hand, during times of expansion, the activity in the markets can pick up.
3. Income From Fees
Another way banks make money is through fees for their services. For instance, if a person wants to keep their bank account open, they can be charged a monthly fee. Other services banks may charge fees for include savings accounts, credit card fees, mutual fund revenue, checking accounts, custodian fees and investment management fees.
4. Interchange Fees
While it is free to use your credit or debit card, a transaction or processing fee is typically generated when a person makes a purchase. This fee is usually charged to the bank where the store is located at. The bank then passes the fee to the merchant, who then deducts the cost of the transaction from their profit.
The advantage of banks having different types of income is that the money can be used to fund operations during times of economic downturns. It can also help banks maintain their profitability during times of lower interest rates.