How Do Banks Make Money in the U.S.?

Have you ever wondered how do banks make money? How is it possible for a bank to provide certain products at now cost or even offer big rewards on accounts like your credit card? Where do banks get the money to give out loans to people?

Below we unpack how do banks make money so you can better understand your bank and make smarter banking choices in the future.  

3 Ways Banks Make Money

Generally, there are three main ways in which banks make their money. First, we will give you an overview, then we’ll take a more detailed look at each one. 

Net Interest Margin

If you’ve ever wondered where banks get the money to provide loans to people, we have the answer right here. They get it from you, their customers. 

When you deposit money into your bank account, you are basically giving the bank permission to use that money to make a loan to someone else. This can be any loan, including student loans, mortgage loans, credit cards, etc.

When banks loan money to people, they charge an interest rate. When you deposit money into your bank account, you can also earn interest on that money. The difference between the interest the bank receives from loans and the interest paid to you for your cash deposited is known as the net interest margin. 

In general, the interest charged on loans is higher than the interest paid to customers, so banks make a profit. 

Interchange

In short, interchange is the money the bank makes for processing debit or credit card transactions. When you swipe your card at a store, that store or merchant must pay an interchange fee. This is another easy way banks make money.

Fees

This is probably one you are more familiar with. All banks charge fees, and banks also have creative ways of charging different costs at different levels. They actually don’t just stick to regular monthly banking fees for your account! Sometimes the fees can get so complicated banks have to create fee guides for you to understand and navigate their fees. 

Now that you understand the basics let’s take a closer look at each of these money-making methods. 

What is Net Interest Margin?

As we explained, the net interest margin is the difference between the interest banks charge when they provide a loan and the interest paid to customers. The bank makes money off the net interest margin when the interest charged to borrowers is more than the interest paid to customers who deposited their money. 

Let’s look at an example. If you invest $100 000 in a savings account that pays an Annual Percentage Yield of 1.5%, in a year, the bank will pay you $1 500 back in interest. The bank will use your $100 000 to provide someone with a student loan with an Annual Percentage Rate of 7%, for example. The APR received by the bank is much higher than the APY paid to you. If the bank does this with thousands of customers, it results in thousands (even millions) of dollars in profit. 

In general, the amount of interest a bank collects on loans is much more significant than the amount of interest they have to pay to their customers with savings accounts. So, the bank is guaranteed of this profit. 

Don’t be alerted by the fact that your bank is loaning your money out to other people. You can still withdraw all your money out of your bank account at any time. Banks are required to keep a minimum fraction of their customer deposits on hand. This is known as the reserve requirement, and the exact amount is set by the Federal Reserve. 

What is Interchange?

The interchange fee is the fee your bank charges for handling a debit or credit card transaction. You don’t have to pay the interchange fee. The interchange fee is paid by the store or merchant you are buying from. 

Usually, interchange fees are a percentage of the transaction value plus a flat rate. For example, if the interchange rate is 2% plus $0.20 and you buy a $200 item at the store, the interchange fee the store will pay to your bank is $4.20. The store actually only gets $195.80 of your payment. 

This is often why there is a minimum value for you to pay with a debit or credit card at a merchant. If your transaction is too small, the merchant loses too much on the interchange fee. 

Most of the interchange fee applicable to a transaction goes to your bank. Sometimes a small portion will go to the merchant’s bank. 

The interchange fee a bank gets when you swipe your credit card is also one reason banks can offer such great credit card rewards. Usually, credit cards get charged a higher interchange fee. So, the bank knows if you swipe your credit card, they will get a higher fee and the rewards they give you is only a small portion of that fee. So, they choose to incentivize customers to instead use their credit cards. 

What Are the Different Bank Fees?

Here are some of the typical fees you can expect to pay with your bank, depending on the type of transaction you are doing. 

Account Fees

These fees are fees paid monthly on different accounts you have with the bank for “maintenance purposes.” This includes fees for checking accounts, credit cards, and investment accounts. 

ATM Fees

Most checking accounts nowadays don’t charge for you to draw cash at your own bank’s ATM. Some accounts that aren’t daily transactional accounts will charge a fee. For example, if you were to draw some money at the ATM from your credit card or savings account. There may also be times when your bank’s ATM is not around, and you have to get cash from another bank’s ATM. Fees for withdrawing from another bank’s ATM is quite substantial. 

Penalty Charges

Banks find many creative ways to charge penalties to you for any small mishap. For example, if you write a check for a small amount more than what is available in your checking account. Or you pay a credit card installment a day late. Penalties are usually quite hefty, so it’s best to try and avoid them. 

Commissions

Commissions are usually applicable to investment accounts where the bank acts as a brokerage. They charge commissions for making trades on your behalf. 

Application Fees

When you apply for a loan, your bank will usually charge you an origination or application fee. Sometimes, this fee is even included in the loan’s principal amount, meaning you pay interest on this fee over the lifetime of the loan. 

Conclusion

Now you better understand how do banks make money. Hopefully, this will help you make smarter banking choices in the future!

Frank Gogol

I’m a firm believer that information is the key to financial freedom. On the Stilt Blog, I write about the complex topics — like finance, immigration, and technology — to help immigrants make the most of their lives in the U.S. Our content and brand have been featured in Forbes, TechCrunch, VentureBeat, and more.

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