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How Do Banks Make Money? Finance 101

Opening a bank account comes with a zero price tag and is usually accompanied by a range of features like a high-interest savings account or free ATM services. But, amidst all these attractive features, have you ever wondered how banks make their money? After all, they are not a charitable organization and are well known for their fat bonus checks (especially big banks). However, it’s not just large banks that make the dough, smaller ones are just as lucrative. Here are three ways banks make money (hint: a lot of it has to do with your money).

Visual Representation Of How Banks Make Money

Banks Save Some- And Lend Some

A major incentive to put money in a bank account is to benefit from high-interest earnings. This is especially true for high yield savings accounts that have interest rates as high as 5 percent.  You may wonder, how handing out free money in the form of interest could benefit the bank but this actually ties into how they make their own money.

When you open a bank account and deposit cash, this money is used to make loans out to other customers. These customers, in turn, pay interest on the amount borrowed. The amount of interest paid depends on the APR (annual percentage rate) which is the cost to borrow the loan from the bank. The interest you earn on the money in your savings account is lower than the interest paid by a customer on the loan. The difference between the two amounts is the bank’s profits AKA the net-interest margin.

Banks make out numerous loans to individuals, small businesses and large corporations every single day. When the process is repeated with millions of customers, just think about how much revenue banks earn!

That Unexpected Bank Fee

While it’s true that banks offer interest on our savings, they also charge a myriad of fees. When opening a bank account, you are provided with an agreement stating the different reasons you may be charged a fee or penalty. Some of the most common fees include ATM fees and overdraft fees. In the U.S, ATM fees can be almost $4.72 per transaction and have hit a record high for the 14th year in a row.

When it comes to an overdraft fee, banks could deny the customer’s transaction at an ATM if the account is overdrawn but this also takes away the opportunity to charge an overdraft fee. Banks make millions in revenue from customer fees each year. When opening a bank account, make sure you have a clear understanding of the fee and penalty policy so that you don’t pay the bank more than you earn.

The Secret Bank Swipe Fee

Every time you swipe your debit or credit card at the store, there is a small fee that needs to be paid by the store or merchant. This fee is called interchange and is one of the many ways that banks make their money. There is however a split in the interchange fee- a large part of it goes to your bank while the rest goes to the merchant’s bank. For instance, if the interchange rate is 3 percent + $0.20 and you bought an item for $100, the interchange fee would be $3.20. The store only gets $96.8 for the purchase and the remaining amount goes to the bank.

If you’ve wondered why banks provide so many incentives and reward programs for their credit cards, the simple answer is Interchange! Transactions that are done using a rewards card usually come with a high interchange fee. The money earned this way contributes to the millions that banks reap in profits each year.

While there are numerous ways banks make money, it is important to remember that the best way to manage your finances it ultimately up to you. Banking policies may differ between institutions, so make sure to weigh your options and shop around before you commit to one. After all, they are making money off your deposits!

Written By: Divya Prem


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