Banks make money in three main ways: earning interest on loans, charging fees for banking services, and generating income from investments and financial services. For many traditional banks, lending is a major source of revenue because the interest borrowers pay is generally higher than the interest the bank pays on deposits and other funding.
However, bank revenue is not the same as profit. Banks also have to pay interest to depositors and other lenders, cover employee and technology costs, operate branches and systems, and absorb losses when some borrowers fail to repay loans.
1. Earning Interest on Loans
Lending money is one of the most important ways banks earn revenue. Banks provide financing to individuals and businesses and charge interest for the use of that money.
Common types of bank lending include:
- mortgages;
- auto loans;
- personal loans;
- business loans;
- credit card balances.
A simple example helps explain how the model works. Suppose a bank has funding on which it effectively pays an average interest rate of 2% per year and makes loans earning 7%. The difference between those rates is 5 percentage points.
That difference does not mean the bank automatically earns a 5% profit. Banks fund themselves in several ways, maintain reserves and capital, experience loan defaults, and have substantial operating expenses. The example simply illustrates the basic relationship between the cost of funding and the return earned from lending.
The term net interest income generally refers to the difference between the interest a bank earns on interest-bearing assets, such as loans and securities, and the interest it pays on deposits and other interest-bearing liabilities.
The International Monetary Fund’s overview of how banks operate explains that banks earn income partly from the spread between the rates they charge borrowers and the rates they pay to obtain funds.
It is also important not to think of each loan as being funded directly by one specific customer’s savings account. Banks manage a much larger pool of assets, deposits, wholesale funding, capital, and other liabilities.
2. Charging Fees for Banking Services
Banks also generate noninterest income by charging for certain services. The exact fees vary significantly by institution and account type.
Examples can include:
- monthly account maintenance fees;
- overdraft fees;
- out-of-network ATM fees;
- wire transfer fees;
- certain loan origination or service fees;
- payment card and transaction-related fees.
Not every bank charges all of these fees. Many checking accounts, for example, waive monthly maintenance charges when customers meet certain requirements, and some banks offer accounts without monthly fees at all.
For a simple example, imagine a bank charges a customer $10 per month to maintain an account. If the fee applies every month and is never waived, that account produces $120 in annual fee revenue for the bank.
Again, that $120 is revenue rather than pure profit. The bank still has expenses associated with operating the account, processing transactions, maintaining security systems, providing customer support, and running its technology infrastructure.
Fees can be an important source of income because they are not directly tied to the difference between lending and deposit interest rates. The Federal Reserve Bank of Minneapolis describes service charges, fiduciary activities, trading-related income, and other sources as forms of noninterest income earned by banks.
3. Earning Income From Investments and Financial Services
Banks can also earn money by holding permitted investments and by providing financial services beyond traditional deposits and loans.
Investing in securities is one part of this activity. Banks commonly hold assets such as U.S. Treasury securities and other debt instruments. These investments can generate interest income and help banks manage liquidity and their balance sheets.
Investments are not risk-free. Changes in interest rates can affect the market value of bonds, borrowers can default on some debt securities, and banks must operate within regulatory and risk-management requirements. Banks cannot simply place customer deposits into any investment they choose without restrictions.
Another source of revenue comes from financial services. Depending on the institution, these can include:
- wealth management;
- investment advisory services;
- asset management;
- trust services;
- investment banking and corporate finance services.
These activities are particularly important for large banks and diversified financial groups. A bank might charge management fees for overseeing client assets, advisory fees for providing investment services, or transaction fees for helping businesses raise capital.
The three-part explanation of bank revenue is useful for understanding the business model, but the categories can overlap in financial reporting. For example, interest earned on bonds is generally classified as interest income, while asset-management fees are typically classified as noninterest income.
How Do Banks Turn Revenue Into Profit?
The basic idea is straightforward:
Bank profit = revenue − expenses.
A bank may earn billions of dollars from loans, fees, investments, and financial services, but it must also cover substantial costs.
Major expenses can include:
- interest paid on deposits and other funding;
- employee salaries and benefits;
- branches, offices, and technology systems;
- regulatory and administrative expenses;
- losses and provisions related to loans that may not be repaid.
This is why a bank with strong lending revenue can still report weak profits if its funding costs rise, operating expenses increase, or borrowers default at higher rates.
In simple terms, banks make money by charging more for the money and services they provide than it costs them to fund and operate those activities. Interest on loans, banking fees, and investment or financial-service income are three of the clearest ways that revenue is generated.