We all understand the role banks play in our lives- A safe keeper and a money lender. However, have you ever wondered how they make profits? After all, they can’t be offering to store your money for free. Well, it’s a simple game. Big banks make big money.
Traditional banks make money from people like you and me, and their many other sources. They charge service fees, interchange fees etc., all of which we will understand in this article. Simply put, no bank can earn until they have our money.
Here, we are going to understand the various ways through which a bank earns money from us.
The game of interest
It is quite evident to doubt why and how the banks afford to pay interest to the savings account? It’s simple! The interest charged on the money lent by them is higher than the interest charged by us on the money saved!
Interest on loans > Interest on deposits
In banking language, they call it the “Net Interest Margin”. Here, they try to decrease the interest rate on the deposits to earn a better profit.
Let’s take an example. A took a loan of $50,000 with the interest rate of 8.5%. This is the basic earning of a bank. On the other hand, B deposited $50,000 at an interest rate of 3.5%. So, the net interest earning of the bank is 5%.
Now, imagine this business taking place with millions of people in the world and the amount of money the banks earn.
Again, banks charge a huge interest when the credit card bills are not paid by the customers on time. The APR that people pay for credit cards can range anywhere from 0% to upwards of 25%. The money (or interest) the banks earn on these unpaid credit cards is another example of banks loaning out customers’ deposits, earning money on those deposits, paying some of that money back to customers checking and savings accounts, and pocketing the rest.
The secondary method of earning is the interchange strategy. Here, the banks earn from the process of credit and debit transactions made by the people. Whenever you swipe your card, the merchant/store pays a processing charge. This charge is known as the interchange fee.
Most of the money goes to your bank, and some charges go to the store’s bank. This interchange fee covers the handlings of the credit and debit transaction.
For example, if the interchange rate is 2%, and someone bought a $100 item, the total interchange fee the store would pay would be $2. The store would get $98 of the actual purchase, and $2 interchange fee goes to the bank that provided you with the credit card.
The fees income
The most profitable scheme of earning by a bank is by applying fees on different services provided by it. Sometimes these fees are extensive and infuriate the customers. The following are the fees that are charged by the banks:
- When someone applies for a loan, a percentage of that loan is charged towards the processing charge or application charge.
- Banks also buy and sell currencies of all the nations of the world, trying to take advantage of the different prices of these currencies against each other, which are changing all the time. They charge a significant amount for these exchange services.
- In case of delay in credit card payment, banks tend to charge a late fee.
- The bank charge fees for applying for a debit card or credit card, also known as a membership fee or annual fee. These fees are said to be for “maintenances purposes” even though the cost of maintaining these accounts is relatively little.
- Another example of a trigger-based fee that generates a significant amount of revenue is the overdraft fee.
- Banks collect commissions for making trades. Most banks will have investment divisions that often function as full-service brokerages. Their commission fees for making trades are higher than most discount brokers.
Banks often provide capital market service for corporations and investors. The capital markets are essentially a market place that matches businesses that need capital to fund growth or projects with investors who require a return on their capital. Banks help the with their in-house brokerage facility.
The other services are sales and trading services, underwriting services, merger and acquisition services. Banks charge a fee in exchange for these services. After all, banks aren’t built to benefit you – they’re built to benefit banks.
Keeping the above points in mind it is better to invest in trades, rather than saving it up in the banks. The former can lead to earning a huge amount of interest, which the bank can never offer if the stocks are managed, properly and wisely.
Unlike traditional banks, Wealthface puts you and your needs first. We don’t nickel-and-dime you with a rock-bottom APY – instead, we pay you interest on your deposits because we believe if we’re making money, you should too. We don’t charge account fees.
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Nonetheless, it is very important to comprehend how the banks operate, and their services provide. Recently, banks are taking a lot of heat for interest rate hikes and fees going out of control due to the Pandemic.