How Banks Make Money

Benjamin in Line at the Bank
Colin Anderson/Blend Images/Getty Images

Whenever you hand over money, it’s important to understand how exactly you pay (and how a business earns profits). That’s especially true for businesses that do nothing but hold onto your money. But in many cases, it’s not clear how financial institutions get paid.

Banks offer numerous “free” services like savings accounts and free checking. You can even boost your earnings by using a certificate of deposit (CD) without necessarily paying fees.

So how do banks make money off of customers? Banks earn revenue from several sources.

The Spread

The traditional way for banks to turn a profit is from borrowing and lending. Banks take deposits from customers (essentially borrowing that money from account holders) and they lend it out to other customers. The mechanics are a bit more complicated than this, but that’s the general idea.

Banks pay interest at relatively low rates to depositors who keep money in savings accounts, CDs, and money market accounts. They usually pay nothing at all on balances in checking accounts. At the same time, the bank charges relatively high interest rates to customers who borrow (using home loans, auto loans, student loans, business loans, and other types of loans).

For example, a bank might pay 1% APY on cash in savings accounts. Customers who get auto loans might pay 4% or more. That means the bank earns at least 3% on those funds – possibly much more than that from riskier customers, or those using credit cards, who pay interest at much higher rates (like 20% APR).

The difference between the low rate that banks pay out and the high rate that they earn is known as the spread.

When banks lend your money to other customers, they’re investing those funds. But banks don’t just invest by making loans to their customer base. Some banks invest extensively in other assets (some of those investments are simple and secure, but others are complex and relatively risky).

Regulations exist to limit how much banks can gamble with your money (especially if your account is FDIC insured), but banks are still able to boost income by taking more risk, and those regulations seem to change over time.

In addition to investing money, banks can charge fees.

Pesky Accountholder Fees

Banking fees have always existed, and some of them are getting easier to dodge, but fees still make a significant contribution to bank earnings. In the past, free checking was easy to find, but now monthly account maintenance fees are the norm – the trick is to get those fees waived.

Banks also charge fees for certain types of actions and “mistakes” you make in your account. If you’ve opted-in to overdraft protection, it’ll cost you $35 or so every time you overdraw your account. Bounce a check? That’ll cost you too. There’s a long list of fees that come as a result of account activity, including (but not limited to):

Service Fees

Banks also earn revenue by offering optional services. You might not pay any of these, but plenty of people (or businesses) do.

Things are different at every bank, but a few common services are listed below.

Credit cards: in addition to interest on your balances, banks might charge annual fees to card users. They also earn interchange revenue or "swipe fees" every time you use your card (debit card transactions bring in much less revenue). That's why merchants would prefer you pay with cash or a debit card, and some stores even pass those fees on to customers.

Checks and money orders: banks print cashier’s checks for important purchases, and many also offer money orders for smaller items. Fees for those instruments are usually five to ten dollars. You can even re-order personal and business checks from your bank, although it’s usually less expensive to replenish online.

Wealth management: in addition to standard bank accounts, some institutions offer additional products and services through financial advisors.

Commissions and fees from those activities supplement bank profits.

Payment processing: banks often handle payments for large and small businesses that want to accept credit cards and ACH payments. Monthly and per-transaction fees are common.

Positive pay: if your business is concerned about fake checks, you can have the bank monitor all outgoing payments before they’re authorized. But of course there’s a fee for that.

Loan fees: depending on your bank and the type of loan, you might pay an application fee, or an origination fee of 1% or so to get a mortgage.

What About Credit Unions?

Credit unions are customer-owned institutions that function more or less like banks. Because they are owned by customers (or “members”) as opposed to profit-seeking investors, and because they are tax-exempt organizations, credit unions can sometimes pursue less profit. They might pay more interest, charge less on loans, and invest more conservatively. However, some credit unions pay interest and charge fees similar to what you’d find at a typical bank.

For more information, see How Credit Unions Work.