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Business News/ Money / Personal Finance/  How do banks generate money while paying you an interest?
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How do banks generate money while paying you an interest?

Alternative financial services, such as investment banking and wealth management, help banks diversify their business models and create revenue. Read the entire article to learn about all of the banks' sources of income in detail.

We explain here how do banks make money (Image by Anand Kumar from Pixabay)Premium
We explain here how do banks make money (Image by Anand Kumar from Pixabay)

Although we all use our bank accounts on a regular basis, most of us are unaware of how banks operate. You might have wondered how banks generate money while giving out interests on bank accounts and providing various free services?

Banks, after all, are a business, and profit is their number one concern. They don't make money until you deposit your money, therefore acquiring and maintaining customers is crucial for them. This is why they provide sign-up and referral bonuses, waive direct deposit fees, and reward high-value clients.

Traditional banks generate their money largely by charging interest on loans to local citizens and small companies. The cash originates from a variety of bank accounts owned by depositors. While many big banks derive the majority of their revenue from interest, they generate a higher amount of non-interest revenue than small banks. Let us discuss in detail the different sources of income for banks.

Income from Interest

Large and diverse banks generate revenue in a number of ways; yet, at foundation banks are mostly regarded as lenders. When you deposit money in a bank account, the bank utilises it to offer loans to other individuals and corporations, on which interest is charged.

In exchange for retaining your deposit, the bank pays you a specified amount of interest. They, on the other hand, earn more interest on the loans they make to others than they pay out in interest to account holders like you. As a result, they make a profit.

For example, your regular checking account may yield you 5% per month, but the bank is utilising that money to issue mortgages at 7%, student loans at 15%, and credit cards at 20%. Hence, at the end, banks make a significant amount of profit.

Income from Interchange Charges

When you use your bank's debit card or credit card to make a transaction, the bank earns profit. When a merchant accepts a card, they pay a merchant discount charge. A percentage of the discount charge goes to the issuing bank for cards issued by them (such as Visa and Mastercard credit and debit cards). This is referred to as an interchange charge.

For example, in order for your transaction to be processed, the cafeteria where you purchase your coffee every morning may have to pay a processing fee to your bank.

Income from various Banking Charges

Banks can also profit handsomely from banking fees. Depending on the sort of account or service you have with the bank, they might vary greatly. These include-

  • ATM fees

Customers are permitted to use ATMs affiliated to banks other than the issuing commercial bank a specified number of times each month. Customers must pay a charge if their ATM transactions exceed a specific threshold. Furthermore, some banks levy an additional fee for transactions made through home ATMs that exceed the established limit.

  • Minimum balance fees

Banks also generate money by charging minimum balance charges. They will charge you a penalty fee if your account balance goes below the minimum level. It's ideal to look for accounts with no minimum balances so you'll have one less item to worry about and pay for.

  • Late payment fees

If a consumer misses a payment or pays their bill late, fees are levied to their credit card or bank account. Make sure you're aware of the due dates on your statements, whether they're in printed or electronic form, to avoid missing a payment.

  • Investment fees

Banks that provide investment services also charge money for managing their customers' investments and providing brokerage services (a fee each time you buy or sell a stock, for example). Commissions or fees may be earned by banks that produce or sell mutual funds, annuities, and other financial products.

Finally, it may be stated that banks are similar to general companies. It just so happens that their product is money. Banks offer money in the form of loans, mortgages and other financial items, whereas other firms provide widgets or services. 

Banks make money by serving as a link between borrowers and depositors. But at the same time, they suffer a variety of costs in order to carry out their activities. In the event that borrowers fail to repay their loans, banks must compensate the losses with their revenues.

 

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Published: 08 Feb 2022, 02:47 PM IST
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