How Do Banks Make Money? Top 15 Ways

Banks are businesses and, like any business, designed to make money. Commercial banks make money off of fees and interest payments from loans and mortgages as well as investment banking and corporate offerings like mergers and acquisitions. They offer financial services, including checking and savings accounts, mortgages, auto loans, personal loans, credit cards, certificates of deposit (CDs) and lines of credit. 

Many commercial banks also offer adjacent services such as safe deposit boxes, brokerage accounts, financial planning and securities lending. Your bank makes money whenever you’re charged a monthly overdraft, low balance fee or out-of-network ATM fee. Read on to understand how banks make money with a detailed review of the 15 most common banking revenue streams. 

Interest on Loans

How banks make money varies, but interest is one of their largest revenue streams. Banks earn money by lending funds to individuals, businesses and governments and charging interest on these loans. Common loans offered by banks include mortgages, personal loans, business loans and auto loans.

Banks measure profitability from net interest margin (NIM), which is the spread between the interest income banks take in on loans and the interest it pays for deposits after accounting for other bank costs. 

For example, If a bank has a $200 million loan portfolio and the net income after deducting expenses is $5 million, the net interest margin is 2.5%. Banks’ net interest margins are affected by the types of loans, the market conditions and market interest rates. Generally, lower interest rates create lower NIM, while higher interest rates can lead to higher NIM. 

Interest on Mortgages

With mortgage lending, the bank offers a fixed loan amount with either a fixed or variable interest rate. Mortgages usually have durations of 20 to 30 years. Standard bank interest rates are calculated based on market interest rates, customer credit history, and credit score. Variable interest rates are pegged on a reference or benchmark rate such as the federal fund or London Interbank Offered Rate (LIBOR).

While mortgages are a loan product, these long-term loans are a primary source of banking revenue and deserve a separate section. Mortgages typically bring in lower interest rates than personal loans or business loans but also offer a long-term stable income for lenders. Banks also make money on mortgage origination fees. 

Banks fund mortgages with funds from their depositors or borrow money from a larger bank at a lower interest rate. Banks calculate the difference between the interest rate it charges customers and the rate it pays for replacing the money borrowed as the yield spread premium (YSP). For example, if the bank borrows money from another bank at 2.5% and lends to borrowers at 6%, the YSP is 3.5%. 

Credit Card Interest

Credit cards are a type of revolving credit that carry some of the highest interest rates of a typical bank’s offerings. The average annual percentage rate (APR) for credit cards ranges from 17.99% to 30% or more. When a borrower charges expenses on a credit card, they have 30 days from the statement closing to pay back the full cost. If they fail to pay the full amount in that time, the credit card starts charging interest on the daily balance. 

For example, if your card has a 24% APR, the daily interest charge is .066%. That means if you carry a balance of $1,000 on a credit card with a 24% APR, you'll pay about $0.66 per day or about $20 per month in interest. Over a year, that’s $240, or nearly one-quarter of the total original balance. 

Because many consumers carry credit card debt, credit cards are a high-interest revenue generator for banks. Consumers who choose only to pay the minimum balance on credit cards maintain a good credit score but end up paying, in some cases, many times the value of the original balance.    

Service Charges and Fees

How do banks get money when they offer some accounts, like checking accounts, for free? Various service charges and fees that banks impose on customers, such as overdraft fees, wire transfer fees and account maintenance charges, offer additional revenue streams for banks. 

Common banking fees include:

• Overdraft or returned item fees
• Monthly account fees on checking or savings accounts 
• Interchange fees or swipe fees
• Loan fees or origination fee 
• Nonbank ATM withdrawal fees
• International debit card transaction fees
• Fees for money orders and cashier’s checks
• Wire transfer fees. 
• Investment banking fees

Deposit Interest Margin

Banks pay lower interest on deposits or money they borrow than the interest they charge, leading to a positive profit margin. Deposit interest margin or net interest margin (NIM) discussed above, is a percentage that expresses the spread between the interest income and the interest it pays for deposits minus other bank costs. 

Investment and Asset Management

Banks also offer investment and asset management services to clients, including businesses and high-net-worth individuals. This can include managing portfolios and offering investment products like mutual funds. 

Banks earn revenue from management fees through investment and asset management, generating an additional income stream.

Trading and Brokerage

Many banks engage in trading activities and brokerage services, buying and selling financial instruments. Banks earn fees or commissions from executing trades on behalf of clients. Investment banking creates strong revenue, especially if the bank charges per trade or position. 

Underwriting and Capital Markets

Banks assist companies in raising capital through underwriting services and participating in capital markets. For example, banks help companies prepare for initial public offerings (IPOs) and earn fees for this service.

Foreign Exchange

Banks profit from providing foreign exchange services, including currency conversion for individuals and businesses. Exchange rate margins are the percentage difference between the mid-market exchange rates and the exchange rate offered to customers. For example, the mid-market rate for converting $100 to euros as of August is 0.91, or 91 euros per $100. 

If the bank changes 0.90 instead of 0.91, the exchange rate margin of 0.1 represents revenue for the bank. Often, banks are able to secure lower exchange rates, increasing exchange rate margins. If the bank exchanges $100,000 to euros, that’s a profit of nearly $1,100 for the bank.  

Treasury Services

Banks offer cash management and treasury solutions to corporate clients. These services aim to maintain cash flow and liquidity while minimizing the cost of funds. Common services include the day-to-day administration of many daily transactions and balancing overall cash inflows and outflows. Banks charge fees for this service, leading to an additional revenue stream. 

Derivatives Trading

Many banks engage in derivatives trading, including options and futures. Banks use derivatives to hedge and speculate on price movements to earn profits. 

Derivatives are structured as contracts between two or more parties in which the value is based on an underlying security or assets such as the S&P index. Underlying securities for derivatives include bonds, interest rates, commodities, market indexes, currencies and stocks. Types of derivatives include swaps, futures contracts and forward contracts. 

Options are one category of derivatives and give the option holder the right without obligation to buy or sell the underlying asset. Options, like derivatives, are available for many investments, including equities, currencies and commodities.

Banks also use credit derivatives to transfer some or all of the credit risk of a loan to another party or to take additional risks. Credit derivatives allow banks to manage their portfolio of credit risks more efficiently while stabilizing returns. 

Mergers and Acquisitions (M&A)

Banks provide advisory services for M&A deals, assisting companies in corporate transactions. The role of banks in facilitating mergers and acquisitions includes advising other companies and executing transactions when business owners sell their company to buyers, acquire smaller companies or divest or acquire specific divisions, companies or assets.

Securities Lending

Banks lend securities from their portfolios and earn fees for the duration of the loan. The most common bank-issued securities are mutual funds, exchange-traded funds (ETFs), pension funds and college endowments. Securities lending builds an additional bank revenue stream through management fees or interest earned on investment. 

ATM Fees

ATMs offer total convenience for people to get cash whenever they need it. Many banks earn revenue by charging noncustomers fees for using their ATMs. The income generated from ATM transactions offers banks an additional revenue stream, especially with ATMs placed in high-traffic areas like tourist locations or major cities. 

Electronic Payment Processing

Finally, banks are vital in facilitating secure and efficient payment processing for businesses. Banks earn fees by processing electronic payments, including debit and credit card transactions. Standard credit card processing fees are 1.5% to 3.5%. 

What Consumers Can Learn from Banking Revenue

Banking is a robust industry that supports national development and economic stability around the world. How do banks get money? From other banks or from generating revenue. As the examples above illustrate, banks make money in incremental amounts. Small amounts like a 50-cent brokerage transaction fee, a 2% credit card processing fee or the nominal difference in foreign exchange rates or interest rates, multiplied by millions, can lead to stable revenue. 
Individual consumers can learn from the power of these small amounts and be more mindful of fees, interest rates and charges to maximize savings. Looking for new financial products? Find some of the best high-yield savings accounts, CDs and interest-bearing checking accounts.

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