HOW BANKS MAKE MONEY?

INTRODUCTION

Generally, all say that bank will lend money at higher rate and give interest rate minimal percent.

I do accept it but not only bank create money by lending loans but also in many ways banks are now an extent reaching every possible corner because of competitive field in society.

Have you ever wondered why your checking bank account is free? Why your bank gives you small amounts of interest every once in a while?

It almost feels like you’re the one making money. So, have you ever wondered how do banks make money?

Whenever you think of bank you imagine bank branches, right? So, banks make money through its branches, but if I tell you most of the branches are loss making.

Banks are companies (normally listed on the stock market) and are therefore owned by, and run for, their shareholders.

Banks need to make enough money to pay their employees, maintain the buildings and run the business.

Banks make money in following ways:

1.0 CHARGING INTEREST ON MONEY THAT THEY LEND

When we deposit money into our bank account, we’re giving the bank permission to use our money to make loans.

The bank loans our money out to others at a cost to the lendee, in the form of an interest rate for mortgages, student loans, car loans, credit cards, etc.

Banks collect money off the interest paid by borrowers, and a small amount of that interest is given back to customers.

This is partially due to customers’ expectation that they will see a return when they deposit their savings with a bank, as well as the bank’s way of saying thank you for banking for us.

The difference between the amount of interest banks earn by leveraging customer deposits through lending products (auto loans, mortgages, etc) and the interest banks pay their customers based on their average checking account balance is the net interest margin.

Even though our money is being loaned out to other people, we can withdraw all of our money out of our bank account right now without a problem.

This is because banks are required to keep a minimum fraction of customer deposits on hand at the bank, known as the reserve requirement.

2.0 CHARGING FEES FOR SERVICES THEY PROVIDE

Most of us are familiar with banking fees. Banks find ways in which to charge their customers all sorts of fees.

With many traditional banks, your checking or savings account agreement will have a long section listing out all the ways in which they charge you fees and penalties.

Some common fees and penalties include: monthly service fees, minimum deposit limits, withdrawal penalties, ATM fees, overdraft fees, and foreign transaction fees that are relatively well known, there’s also a host of other fees that banks may charge customers.

So, when choosing a bank, it’s always important to read the fine print to make sure you’re aware of when you might be charged.

2.1 Account fees 

Some typical financial products that charge fees are checking accounts, investment accounts, and credit cards. These fees are said to be for “maintenances purposes” even though maintaining these accounts costs banks relatively little.

2.2 ATM fees

There will be times when you can’t find your bank’s ATM and you must settle for another ATM just to get some cash. Such situations happen all the time and just mean more money for banks.

2.3 Penalty charges

Banks love to slap on a penalty fee for something a customer’s mishaps. It could a credit card payment that you sent late. It could be a check written for an amount that was one penny over what you had in your checking account.

Whatever it may be, expect to pay a late fee or a notorious overdraft fee, it sucks for customers, but the banks are having a blast.

2.4 Commission

Most banks will have investment divisions that often function as full-service brokerages. Of course, their commission fees for making trades are higher than most discount brokers.

2.5 Application fees

Whenever a prospective borrower applies for a loan (especially a home loan) many banks charge a loan origination or application fee. And, they can take the liberty of including this fee amount into the principal of your loan—which means you’ll pay interest on it too!

3.0 INTERCHANGES FROM CREDIT AND DEBIT TRANSACTIONS

Interchange is the money banks make from processing credit and debit transactions. Each time you swipe your card at a store, the store, or merchant, pays an interchange fee.

The majority of money from interchange goes to your bank–the consumer’s bank–and a little goes to the merchant’s bank.

The fees are paid to the card-issuing bank to cover handling costs, fraud and bad debt costs and the risk involved in approving the payment.

Card-issuing banks, payment processors (which may or may not be the issuing bank), credit card payment networks like MasterCard and Visa, payment gateways, and the merchant’s own bank will all charge a percentage-based fee on every transaction, and these charges frequently appear as a single, bundled amount on the bills your payment processor hands you.

Interchange is also how many banks are able to offer such high credit card rewards. Merchants are assessed at a higher interchange fee when reward program credit cards are used to make purchases.

Some banks cover the cost by charging membership fees to credit or debit card holders.

Because merchants have no control over interchange fees, there has been a lot of discussion as to how much banks should be allowed to charge for this fee.

4.0 TRADING FINANCIAL INSTRUMENTS IN THE FINANCIAL MARKETS

Financial markets are a type of marketplace that provides an avenue for the sale and purchase of assets such as bonds, stocks, foreign exchange, and derivatives. 

Businesses and investors can go to financial markets to raise money to grow their business and to make more money, respectively.

There are so many financial markets, and every country is home to at least one, although they vary in size.

Some are small while some others are internationally known, such as the New York Stock Exchange (NYSE) that trades trillions of dollars on a daily basis.

Here are some types of financial markets.

4.1 Stock market

The stock market trades shares of ownership of public companies. Each share comes with a price, and investors make money with the stocks when they perform well in the market.

It is easy to buy stocks. The real challenge is in choosing the right stocks that will earn money for the investor.

4.2 Bond market

The bond market offers opportunities for companies and the government to secure money to finance a project or investment.

In a bond market, investors buy bonds from a company, and the company returns the amount of the bonds within an agreed period, plus interest.

4.3 Commodities market

The commodities market is where traders and investors buy and sell natural resources or commodities such as corn, oil, meat, and gold. A specific market is created for such resources because their price is unpredictable.

There is a commodities futures market wherein the price of items that are to be delivered at a given future time is already identified and sealed today.

4.4 Derivatives market

Such a market involves derivatives or contracts whose value is based on the market value of the asset being traded.

The futures mentioned above in the commodities market is an example of a derivative.

CONCLUSION

There are four main ways banks make money: (i) charging interest on money that they lend, (ii) charging fees for services they provide, (iii) interchanges from processing credit and debit transactions, and (iv) trading financial instruments in the financial markets.