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How Do Banks Make Money and Generate a Profit?

How Do Banks Make Money and Generate a Profit?
Chris Alexis
Chris AlexisUpdated March 9, 2023
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Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.
Many people wonder how banks make money. After all, some banks don’t charge monthly fees for maintaining and managing your accounts. Are you getting something for nothing?Not exactly. The main way banks make money is by lending the money you deposit into your account to borrowers who pay them interest on those loans. The interest rate they earn from borrowers is higher than the interest they pay on your deposits, which is how they can net a profit.Banks also make money by charging various fees and by offering other services, such as investment banking and wealth management. Here’s a closer look at how banks make a profit.

Different Types of Banks

Exactly how a bank makes money will depend on what type of bank it is. Here’s a look at some of the most common types of banks, how they work, and how they earn money.

Investment Banks

Investment banks provide a variety of financial services to wealthy individuals, corporations, and governments. This includes research and underwriting, advising companies on merger and acquisition (M&A) deals, and facilitating initial public offerings (IPOs). They make a profit by charging fees and commissions for these different services.

Commercial Banks

This is the kind of bank most individuals and small and midsize businesses use. Commercial banks offer a range of financial services, including savings and checking accounts, credit cards, auto and personal loans, mortgages, and lines of credit. They may also offer safe deposit boxes, brokerage accounts, and financial planning. Commercial banks earn money through interest on loans, as well as fees they charge customers.

Retail Banks

Retail banks are banks that only serve individual consumers, not businesses. Like commercial banks, retail banks offer different types of bank accounts, loans, and credit cards, and make a profit by charging a higher interest rate on loans than they pay on their deposit accounts, as well as fees.

Online Banks

An online bank is a bank that does not have any brick-and-mortar branches. These banks earn money in the same way that commercial and retail banks earn money. However, due to their lower overhead, they typically charge lower fees and offer higher interest rates on deposit accounts than the average interest rate on a savings account.

Central Banks

Unlike any of the bank types listed above, a central bank is a financial institution that is responsible for overseeing the monetary system and policy of an entire country. The goal of a central bank is not to make a profit but to regulate the country’s money supply and set interest rates. In the U.S., the central bank is the Federal Reserve System, a.k.a. "the Fed".Recommended: What Is a Community Bank?

How Do Banks Earn Income?

The ways that banks make money will vary depending on the type of bank and its target customers. But here are some of the most common ways banks earn a profit.

Interest Income

Interest income is the primary way that many banks make money. They do this by taking money from depositors who don’t need their money right now. In exchange for putting their money in the bank, the bank pays these depositors a certain interest rate, typically expressed as an annual percentage yield (APY). The bank then lends out these funds to borrowers who need money right now. These borrowers pay an annual percentage rate (APR) that is typically higher than the APY the bank pays depositors. The bank profits from this spread.

Interchange Fees

When you use your credit or debit card to make a purchase, you’re actually helping the bank that issued the card make money. This is because that transaction has what’s called an “interchange fee” attached to it. You’re not paying it — the merchant accepting the card is. These interchange fees are also known as “swipe fees” and typically include a small fixed fee plus a percentage of the total sale.

Capital Markets-Related Income 

Investment banks provide services, known as capital markets services, for corporations and wealthy investors. These services include asset management, IPOs, underwriting services, and advice on M&A deals. In exchange for these services, customers pay the bank fees and commissions.

Fees 

Banks charge a variety of fees that help them earn a profit. These include:
  • Account fees Banks often charge customers a monthly account management fee on their checking and/or savings accounts.
  • Other bank fees On top of monthly fees, banks often charge other fees, including overdraft fees, minimum balance fees, excess transaction fees, and fees for using an out-of-network ATM. 
  • Service fees Banks often change fees for certain add-on services, such as getting a money order or cashier’s check or using your debit card overseas.
  • Loan fees Bank loans often come with origination fees, application fees, late fees, and prepayment penalties,
  • Investment fees Banks that offer investment services may charge fees each time you make a trade.
  • Credit card fees Banks that issue credit cards will often charge cardholders an annual fee, as well as usage-based fees, such as fees for cash advances, balance transfers, and late payments.

Advisory Services

Some banks earn money by offering advisory services to businesses and corporations. They might advise a company on how to raise capital, for example, or help facilitate an IPO or M&A deal.

Commissions

Banks often earn commissions by referring customers to companies they have standing partnerships with, such as insurance agents, brokerages, and financial services companies.

What Are the Main Expenses Banks Pay? 

Banks have two main types of expenses: interest expenses and noninterest expenses.Interest expenses refer to the money the bank pays customers who hold interest-bearing accounts. Noninterest expenses are all the other costs a bank incurs to keep its doors open. This includes employee salaries, equipment, rent, utilities, web hosting, legal counsel, and IT support. 

Credit Unions vs Banks

While banks and credit unions offer similar financial products, they function in different ways. Banks are typically for-profit institutions, whereas credit unions are set up as not-for-profit businesses. Unlike banks, which distribute profits to their shareholders, credit unions distribute their profits to their customers (who are called “members”). Credit unions also tend to serve a specific geographical area or a specific group of people. Their mission is to give members the best rates, fees, and APYs they can while covering the costs of their operations.Recommended: Banks vs Credit Unions Compared

Ways to Reduce Your Banking Costs 

Banks are in the business of making a profit, and have several different ways of making money. But that doesn’t mean you have to pay a lot to get the banking services you want. Here’s a look at some smart ways to save.Go paperless Because printing and mailing statements costs banks money, they will often waive monthly account fees if you opt for online-only statements.Keep an eye on balances. Banks often waive monthly account fees if you maintain a certain minimum daily balance in the account. However, if your average balance at the end of even one day dips below the threshold, it could trigger a fee for that month.Only use in-network ATMs. Using ATMs that aren’t affiliated with your bank can lead to charges from your bank, as well as the ATM provider. Many banks offer apps that tell you where to find a fee-free ATM.Enroll in direct deposit. Direct deposit eliminates the cost of check handling and increases cash flow for banks. As a result, they will often waive monthly fees, and possibly offer a higher APY on your accounts, if you set up direct deposit. Shop around. While banks sell similar products, they don’t all charge the same fees or pay the same interest rates. You can often find the best deals at online banks. Recommended: How to Switch and Change Banks

The Takeaway

Banks generally make money by using depositors’ funds to offer loans to borrowers and charging them a higher interest rate than they are paying on the deposits. Banks also make a profit by charging bank fees and offering other services, such as investment banking and wealth management. If you’re looking for a savings account that charges low, or no, fees and pays a competitive APY, it can pay to shop around. Not sure where to start your search? With Lantern by SoFi’s online banking marketplace, it’s fast and easy to compare high-yield savings accounts based on APY, fees, and balance minimums. Lantern can help you compare online savings accounts and find today’s best rate.

Frequently Asked Questions

Do banks earn from securities?
What is the primary source of income for banks?
What do banks use their income for?
Where do banks get money to loan out?
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About the Author

Chris Alexis

Chris Alexis

Chris Alexis has been putting pen to paper and fingertips to keyboard since his youth. He ultimately grew into an accomplished and award-winning writer who loves using the power of language to connect with audiences. He also strongly enjoys learning about who he is writing for so he can create something that will truly resonate with them. He has worked for a variety of companies, each of which have given him more experience and insight.
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