How Do Banks Make Money?

Banks make money by lending your money out at interest and by charging you for services provided. When they lend your money they have to balance their objectives of creating as much income as possible for themselves, with their obligation to play it safe and maintain security for that money. They also have to maintain a good liquidity position in case you and all other customers want to draw cash out.

Liquidity and profitability are sometimes opposite positions - one cannot generally have both at once. If you are able to lend your money for long periods then a lot of interest can be earned. However the bank cannot lend so much of that money out that they prevent their customers from having access to their cash when they want it.

Banks therefore run the operation like a businesses because, in fact, that’s what they are - a business. Your business’s product may be a piece of equipment or machinery or clothing or food. The bank’s product is cash, or money. They sell this money in the form of loans and other financial type products. They make their money on the interest and fees they charge on these loans and they pay others for that money. These others are their customers.

The key is, banks must get more interest income coming in from loans given out, than the cost of interest they pay have to pay out (to customers for allowing their funds to be deposited with them).
The other big revenue items generated by banks are the fees they charge. The old days where only a small portion of the bank’s income came from fees charged has long gone.

Today, bank fees make up a substantial bulk of the bank’s earnings and they charge for every service, whether it is for an electronic transaction, or honouring a withdrawal from an ATM machine, or permitting a transfer through the Internet banking system. Bank’s fees add up to multi millions worth of income for the bank but are a constant source of aggravation and annoyance to customers.

Another large source of income for the bank is returns from investment and securities. Here the banks take some of the funds they hold and purchase other products, such a shares or equity in businesses. This in turn generates profits, which is received by the bank by way of dividends etc.

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