Banks make money mainly by using deposits to fund loans and charging borrowers a higher interest rate than what is paid to depositors, creating a profit from the interest rate spread. In addition to net interest income, most banks also earn fees from account charges, transaction fees, loan origination and processing fees, wealth management, and investment banking activities. Here’s a concise overview:
- Core mechanism: Interest income
- Banks take deposits from customers (checking, savings, CDs) and pay a certain interest rate on those deposits.
- These funds are lent out to individuals and businesses at higher interest rates.
- The difference between the interest charged on loans and the interest paid on deposits is the net interest margin, a primary source of profit for many banks.
- Fees and service charges
- Monthly maintenance fees, overdraft fees, ATM and transaction fees, safe deposit box rents, and other service charges contribute to revenue.
- Banks also earn fees from loan origination, credit card processing, and financial advisory services.
- Additional earnings
- Banks engage in wealth management, asset management, and investment banking, which can generate commissions, advisory fees, and trading gains.
- Some banks hold securities and earn income from investments and trading activities, subject to risk and regulatory constraints.
- Money creation concept (high-level)
- When banks issue new loans, they typically create new deposits in the borrower's account, effectively expanding the money supply. This process is often described as “money creation” by banks through lending, within regulatory and monetary framework limits.
- Regulatory context
- Central banks influence broad lending conditions via policy rates and reserve requirements (where applicable), which tools affect banks’ ability to lend and their funding costs.
- Banks must manage credit risk, capital adequacy, liquidity, and compliance to maintain safety and soundness.
If you’d like, I can tailor this to a specific country (e.g., the U.S., UK, or India) and include typical figures like net interest margins, common fee structures, and how regulatory capital requirements shape bank profitability.
