While it might be a no-brainer that a bank is where you can safely stash your cash, earn money from compound interest on deposits and take out a loan. But how do banks make money? After all, financial institutions are a type of business, so they need to generate revenue in return for all the services and products they offer.
Below, we'll explain how a bank makes money, the different strategies for generating profits, and how you (the customer) can save a few bucks and get the most out of your banking by doing your homework when shopping around.
1. Different Types of Bank Fees
Monthly Maintenance Fee
This is a fee you might have to pay to maintain your account. Not all banks charge a monthly account or maintenance fee, and some may drop the fee altogether as long as you either keep a minimum amount (i.e., $200) in your account or perform a certain number of transactions each month. A heads up: Riverstones Vista Capital does not charge a monthly maintenance fee for its High Yield Savings account.
Out-of-Network ATM Fees
While a bank has its own network where you can withdraw or deposit cash fee-free, if you use an ATM that's out-of-network, you might expect to pay a charge. ATM fees might come with two separate charges, a bank fee and a surcharge for using the ATM. A bank might offer a certain number of free out-of-network ATM transactions per month.
Overdraft Fees
You'll get hit with an overdraft fee if you don't have enough money in your account to cover a transaction, and the bank temporarily covers the shortage. In return for this courtesy, you incur an overdraft penalty. While banks typically have a limit as to how many transactions in a given day you can get slammed with an overdraft fee, these overdraft fees can add up quickly.
According to a report released by the Financial Health Network (FNH), overdraft and NSF fees for households in the U.S. totaled $11 billion both in 2020 and 2021. 4
While you will get hit with an overdraft fee for checks, recurring debit or online payment, you'll need to opt-in to overdraft for debit card transactions and ATM withdrawals.
Insufficient Funds Fee
If you don't have enough funds to cover a transaction and the bank declines to cover it and returns the payment it can trigger an insufficient funds fee (NSF) from the bank—think of it as a returned check. The good news is that a number of banks are dropping this fee on checking accounts, which means consumers might pay 50% less on these fees each year, saving them $1 billion as a whole.5
Paper Statement Fees
This fee kicks in if you receive a monthly paper statement detailing your bank balance and transactions. The good news is often this fee can be waived if you opt for paperless statements instead.
Inactive Account Fees
Should your account lay dormant for a certain stint of time, you might have to pay an inactive account fee. How long does your account need to be inactive before you get hit with such a fee? It depends, but usually between six and 12 months.
Account Closing Fee
The bank might charge a fee to close your account. This isn't as common as other types of fees, and is more likely to occur if you close your account within a certain time frame after opening an account—say after 30 or 60 days. This is also more likely to occur if you close a certificate of deposit (CD) prematurely, where you'll get hit with an early withdrawal penalty.
2. Credit and Lending
Beyond standard bank fees, here are some of the other ways a bank can earn money.
Interest on Loans
Banks also make money by lending money in the form of personal loans, mortgages, auto loans and small business loans, to name a few. The funds a bank lends come from customer deposits, and the interest rate they offer customers for stashing their cash in a savings or checking account is less than the interest rate they charge on loans.
For example, let's say a bank offers 2% interest on deposits to a savings account, which costs them money. But they also offer personal loans at an interest rate of 10%, which is a money-earner for them. As you can see, the bank is making money because the interest rate on the loan is higher than what's offered for a savings account.
Interest from Credit Card Accounts
When a bank issues a credit card, it earns money through interest from credit card accounts as well as related fees—think late fees, over-the-limit fees and foreign transaction fees. Banks also make money from a credit card's interchange fees or merchant fees: each time a retailer processes a credit card payment, it must pay an interchange fee, which is a percentage of the transaction amount.
3. Financial Advisory Services
While a bank might walk you through your personal loan options as a courtesy, it can also offer customized guidance for a fee on a spat of areas, such as wealth management, investments or retirement. There are different ways that a financial advisor at a bank might charge, such as a percentage of assets under management (AUM) or by a flat fee. Some might offer certain services at an hourly rate.
4. Investments
A bank typically takes money that customers deposit and invests it. Exactly what a bank invests in can vary greatly, and can hinge on its area of expertise, the economy and also the bank's mission and values.
Do Banks Create Money?
Banks don't create money out of thin air, but they do create money in the form of assets through loans. A commercial bank creates money by turning the borrower's ability to repay in the future into bank deposits.
So whenever a bank issues a loan to a customer, a matching deposit is also created on the "what is owed" side of the balance sheet. So that IOU (aka this borrower will repay in the future) is transformed into money (aka the bank deposit).
That being said, a bank needs to have access to liquid reserves to create money. In other words, a bank can't just conjure infinite amounts of money. Plus, the deposit that is created needs a certain amount of reserves to be held against it, which is supplied by the Federal Reserve (the U.S.'s central bank).
How Much do Banks Make?
As you might imagine, banks have evolved and changed dramatically over several centuries. Per the Federal Deposit Insurance Corporation (FDIC), in 2021 there were over 4,200 commercial banks in the U.S.2 and they reported $279.1 billion in profits.3
The Bottom Line: Do Your Research
When choosing a bank, it's important to do your homework: check the terms and conditions, interest rates and fees before committing. This information can often be obtained online, and you can reach out to speak to a customer service rep with any questions.
Beyond that, look for ways you can potentially earn more and save on some of these fees. For instance, stay on top of your bank balance, opt out of paper statements and pay your credit card balance on time. If you're looking for a credit card or to take out a loan, study the interest rates, fees and terms before making a decision.
The relationship you have with your bank is an important one. By understanding the ins and outs of how a bank operates, you can cultivate a long-term connection that can meet all your banking needs, where you have your banking needs met, and make your money work for you.
Jackie Lam is an L.A.-based money writer whose work has appeared in Salon.com, CNET, Refinery29, Business Insider, and BuzzFeed, among others.
LEARN MORE: The ABC's of Banking: What is a Bank and How Does it Work?
Sources
1. (n.d.). A History of Central Banking in the United States. Federal Reserve Bank of Minneapolis.
2. (n.d.). BankFind Suite: Find Annual Historical Bank Data. FDIC.
3. (2022, March 1). U.S. Bank profits rose in 2021, FDIC says. Reuters.
4. (2022). FinHealth Spend Report 2022. Financial Health Network.5. Borné, R., & Vasan, A. (2022, April 13).
5. Consumers on course to save $1 billion in NSF fees annually, but some banks continue to charge these fees. Consumer Financial Protection Bureau.