At first glance, it may seem like banks offer their key services, like checking and saving accounts, at a low (or even no) cost to their customers. Which begs the question, how do banks make money?
A bank is a business. And, similar to any other profit-driven business, banks do charge money for the services and financial products they provide. The two main offerings banks profit from are interest on loans and fees associated with their banking services.
Read on for a basic breakdown of these services and find out exactly how banks make money from them. You may be surprised to learn how banks are making money off of you.
What Exactly is a Bank?
In general, a bank is a financial institution licensed to receive deposits and make loans. Some banks also offer financial services, such as safe deposit boxes and currency exchange.
There are several different types of banks, and though they all generally provide similar services, each type has a few unique traits that can make it especially useful for certain types of customers and goals. Here are some of the most common types of banks.
Traditional banks that serve the general public, such as Wells Fargo, Bank of America and Chase, are retail banks. Their focus is to help people manage their personal wealth.
Retail banks are generally easily accessible, often having hundreds of branches across the country and they provide the most basic of financial services for regular use.
Commercial or Corporate Banks
These banks specialize in providing financial support and assistance to small and large-scale businesses. Many also have retail divisions as well.
Where a standard retail bank might only be able to provide small personal loans, commercial banks often have the capacity to provide larger and more substantial loans, as well as other services, to help support new and expanding business ventures.
These are institutions that provide financial services just like any other bank, except they do not maintain any actual storefronts. To apply for an account with an online bank, such as Ally, Wealthfront, or Synchrony, applications must be submitted online and the entire banking experience is primarily conducted remotely via an internet browser or app.
Because online banks generally don’t have the expenses that come with maintaining a storefront, they can often offer higher interest rates and lower fees than many brick-and-mortar banks.
However, because they don’t have storefronts, you typically can’t make cash deposits.
In many countries, banks are regulated by the national government or central bank. In the U.S., the Federal Reserve System is the central bank of the U.S. It consists of 12 Federal Reserve banks that stretch across the country.
These central banks are responsible for implementing monetary policy, maintaining the stability of the financial system, controlling inflation, and providing financial services to banks and credit unions. The Federal Reserve banks are essentially banks for other banks, as well as the government.
Morgan Stanley and Goldman Sachs are examples of investment banks. These banks specialize in managing some of the largest and most complex types of commercial transactions, such as merger and acquisition activity, initial public offerings, or financing large infrastructure projects like building bridges.
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How do Banks Make Their Profits?
With the wide variety of financial products and services that banks offer, they create many opportunities for revenue. Those revenue streams generally fall into one of three categories:
One of the primary sources of income for banks and financial institutions comes from interest collected on the various loans that they offer.
Banks use the money from their clients’ checking and saving accounts to offer loan services. They then charge interest on these loans (based on the credit history of the borrower and the current federal funds rate). Banks then profit from the net interest margin–which is the difference between the higher interest income charged for their loans and the lower interest paid out to clients on their bank accounts.
When people use their bank-issued credit and debit cards at a store, that store typically pays a processing fee–known as an interchange fee.
These fees are paid by the merchant’s bank to the consumer’s bank for processing a card payment. This fee is to help ensure security, payment, fraud protection and a speedy transfer of funds, and is typically a small flat fee plus a percentage of the total purchase.
Interchange fees help explain why some establishments maintain minimum purchase amounts for credit or debit card purchases.
Banks typically bring in a significant amount of their money by charging customers fees to use their products and services. Banks may charge fees to create and maintain a bank account, as well as to execute a transaction. They may be recurring or one-time only charges.
All banks should be upfront about all of their fees and disclose them somewhere accessible to their customers. You can often find a bank’s fee schedule online or in the documents you received when you opened your account.
It can be a good idea to learn about the types of fees that your bank charges in order to avoid or minimize fees, and also catch any errors. If fees seem unreasonably high, you might also decide to switch to a different bank or financial institution that charges less.
Some of the more common bank fees include:
Service fee: A monthly fee charged for keeping an account open.
Account maintenance fee: A monthly fee charged for managing an account.
Withdrawal limit fee: Charged when a customer exceeds the maximum number of monthly withdrawals allowed on a savings account.
ATM fee: Charged when withdrawing funds from an ATM terminal outside of your bank’s network.
Card replacement fee: Charged when a lost or stolen debit or credit card is reissued.
Overdraft fee: Applied when a customer’s bank balance falls below zero. Interest can also accrue on the overdrawn amount, as the bank may see this as a short-term loan.
Non-sufficient funds (NSF) fee: Charged when a customer makes a transaction but doesn’t have enough money in their account to cover it. The transaction “returns” or “bounces,” and the bank charges the customer an NSF fee.
International transaction fee: Charged when making a debit card purchase in a foreign currency or withdrawing foreign currency from an ATM.
Cashier’s check fee: A fee for purchasing an official check from your bank.
Stop payment fee: Applied when requesting that a bank stop payment on a pre-written check from your account.
Wire transfer fee: Charged for electronically transferring funds from one bank to another.
Paper statement fee: A fee for providing monthly bank statements in the mail rather than digital statements online.
Credit Unions Vs. Banks
A credit union is a nonprofit, member-owned financial institution that, like a bank, makes loans and offers checking and savings accounts.
Members purchase shares in the credit union, and that money is pooled together to provide a credit union’s services. Individuals interested in banking with a credit union must fit specific eligibility requirements (sometimes regional, employment-related, or requiring direct relation to an existing member) and apply for membership.
Unlike a bank (which is a for-profit business), a credit union returns its profits to members, which means it may have lower fees and better interest rates on savings accounts and loans than traditional retail banks.
Because they are often smaller entities, however, credit unions tend to provide a limited range of services compared to banks. They may also have fewer locations and ATMs.
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To make a profit and cover their operating expenses, banks typically charge for the services they provide.
When a bank lends you money, for example, it charges interest on the loan. When you open a deposit account, such as a checking or savings account, there are typically fees for that as well. Even fee-free checking and savings accounts often come with some fees.
It can be wise to take a second look at the fees outlined in your banking contract in order to get ahead of any surprise charges down the line.
If you’d rather steer clear of fees and excess charges, SoFi Money® can be a great option.
SoFi Money is a cash management account that doesn’t charge any account fees, monthly fees, or overdraft fees. Plus, members have access to 55,000+ fee-free ATMs.
SoFi Money is a cash management account, which is a brokerage product, offered by SoFi Securities LLC, member FINRA / SIPC . Neither SoFi nor its affiliates is a bank. SoFi Money Debit Card issued by The Bancorp Bank. SoFi has partnered with Allpoint to provide consumers with ATM access at any of the 55,000+ ATMs within the Allpoint network. Consumers will not be charged a fee when using an in-network ATM, however, third party fees incurred when using out-of-network ATMs are not subject to reimbursement. SoFi’s ATM policies are subject to change at our discretion at any time.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Any SoFi member who receives $1,000 or more in qualifying direct deposits into their SoFi Money account over the preceding 30 days will be eligible for Overdraft Coverage. Overdraft coverage only applies to SoFi Money accounts and is currently unavailable for Samsung Money by SoFi accounts. Members with a prior history of non-repayment of negative balances for SoFi Money are also ineligible for Overdraft Coverage.