Everyone reading this article will have a savings account or checking account with a local high street bank; most of these are free, so how do banks make money exactly?
We all use bank accounts every day of our lives, but only some of us know precisely “how do banks make money“.
We have all heard the stories of bankers making millions and spending lavishly, but how do they afford to do this when the bank accounts we are opening with them are free at the point of use?
Surely they can’t all be making that much money, can they?
The quick answer to this question is, yes, banks make a lot of money.
They make their money in various ways, the main ways being interest on loans, fees charged for services, investments, and other banking fees.
When you deposit your money into the bank, what do you think happens to that money?
Do you think it is sitting safely in a vault collecting dust, waiting for you to come and draw it out one day when you need it?
Well, the answer to this is no, it’s not; as soon as the banks have your bank deposits, they turn around and lend it to someone else as credit card debt, a loan, a mortgage, or other financial instruments where they can make money from using your money which you deposit into your account.
The bank will lend your money out, in the case of credit card debt, at an APR of 30%+ while paying you 1 or 2% interest on the money that they have lent out.
Have you heard of the phrase “a run on a bank”? This is where many customers demand the withdrawal of their money from a single bank simultaneously.
Even though everybody’s bank balance will show what they have in their account, the bank wouldn’t have the liquidity to pay everyone’s money back to them at the same time; this is because they have lent it out and invested it to make themselves more money.
So, how do banks make money on individual products?
Banks have various methods of extracting money from their clients with multiple types of fees. Below are some of these bank charges explained in a bit more detail.
By far, the most significant way banks earn money is through the charging of interest on loans and generating interest income, when you take out a loan from a bank, whether an auto loan, a mortgage, a personal loan, or a business loan, you will pay interest on top of the original loan amount.
The amount of interest charged will depend on several crucial factors when you take it out, including the type of loan, the length of the loan, and your credit score, but it typically ranges from around 3% to 10%.
When you are borrowing money, you must read all of the terms and conditions that the banks offer, and make sure you read the small print so that you aren’t hit with any unforeseen monthly maintenance fees.
When a company wants to make an initial public offering (IPO), they usually hire an investment bank to underwrite the IPO.
Commercial banks provide bank accounts and financial services for businesses. Their services include business loans, credit cards, and lines of credit. They also offer merchant services, which allow companies to accept credit card payments and charge a transaction fee on every sale.
The fees for these services vary depending on the type of service and the banks. For example, a business that wants to open a line of credit will usually pay a higher fee than a business that wants a basic checking account.
If you do not maintain a minimum balance above zero, The banks charge an overdraft fee when a customer spends more money than they have in their account.
The banks will also charge interest on the amount of money that has been overdrawn.
Some banks will also charge an annual or monthly service fee for some of their accounts and services. This is usually a percentage of the total amount deposited into the account or a flat rate fee.
Annual, or monthly account fees can also be changed if you don’t maintain a minimum account balance, so make sure you know what that is before opening an account.
Another way banks make money is through transaction fees. Whenever you use your debit/credit card to make a purchase, the bank will charge the merchant a small fee for processing the transaction. The banks will also charge you a fee if you make a withdrawal from an ATM that is not affiliated with your bank.
Foreign Transaction Fees
If you use your debit or credit card abroad, the banks will also charge you a foreign transaction fee. This is typically around 3% of the total amount spent.
Suppose you use your regular debit or credit card abroad to withdraw cash. Banks will also charge excessive withdrawal fees if you try to withdraw cash from an ATM abroad.
As a regular traveler, I have just discovered the Revolut card, which I just obtained for a trip to Portugal recently., and I am impressed with it.
You preload the card with your local currency, then use the contactless card, and the forex trades are made as you spend with no hidden fees.
This means you save all foreign transaction fees from your traditional bank. The bank card partners with an app on your phone, making it really easy to use and really easy to check your balance. Check them out here to save money if you are spending abroad.
The banks will also charge late payment fees if you miss a credit card or loan payment. The banks will also report any late payments to credit agencies, which will damage your credit score.
So try to make all payments on credit cards or loans on time every month.
What to consider when you are choosing a new bank.
The main ways are through interest on loans, fees charged for services, and investments. By understanding how banks make their money, you can be a more intelligent consumer and avoid some fees that banks charge.
When choosing a financial institution, you need to understand your needs and how bank fees and interest expenses will impact your money.
Before you consider moving to a new banking institution, be mindful of how you will use your bank account, what the banking costs are, what ATM fees are, minimum balance fees, etc., as these are all the ways traditional banks can take money from you.
Now you are armed with all the detail you need so that the banks can’t take as much money from you as they would have without this knowledge.
Lee, now the author of Learn Life Money, has started businesses in various industries such as E-commerce to social media marketing. He is an award-winning entrepreneur having received awards from Dragons Den Theo Paphitis, and winning awards for the fastest-growing social media marketing agency in 2019, You can read his full story here. Lee helps people to start and scale their businesses using their knowledge and experience. He has a passion is to help others achieve the success he has achieved and wants to help people pave their path to financial freedom from making the right decisions with money to starting their own businesses.