Most of us use a commercial bank to safely store our money. However, how much do we know about how banks work, especially when it comes to lending money? Banks get their money in a few different ways. Keep reading for more information on how banks get money to lend out.
The Primary Way That Banks Make Their Money
The main way that banks make money is from their customers who deposit with them. They then use that money to then lend to other customers. Here is more information on how this works for profit:
Banks will set up incentives of interest (averaging from 0.01% to 0.03%) for customers who decide to keep their money with them. This money is then added to a larger pool from which they lend. This loan money will have significantly higher interest rates than what the bank gives to depositors. For example, banks will lend at an average between 10% to 30%. Exact interest rates for bank loans are based on a few factors including the loan type and borrower’s creditworthiness.
With this in place—a lower interest rate for deposits and a much more significant one for lending—banks can profit.
With bank lending, banks rely on a fractional reserve banking system. This system allows them to lend more than the actual amount of deposits at hand, creating a money multiplier effect for profit. The federal reserve sets the regulatory capital requirements banks need to maintain in order to lend money.
So, Is My Money Safe With a Traditional Banking System?
Knowing banks use their customer funds to lend out can sound slightly alarming. But, most commercial banks and regional banks have FDIC (Federal Deposit Insurance Corporation) insurance, which protects customers’ money up to $250,000 in case of a financial crisis or anything else that can put banking customers’ money at risk.
What Kinds of Loans Do Banks Have?
You may hear about bank loans—an umbrella term for loans you can get from a bank. There are all kinds of loans that a bank can give out, which usually make up most of their revenue; here are some examples:
Personal Loans
Personal loans are loans with monthly installments and are some of the most common and versatile options available. They can be for a large or small amount. The interest rates and eligibility will vary depending on your credit history and the bank’s Underwriting.
Business Loans
Business loans can be used by small or large businesses to start, maintain, or grow. These loans are usually for several thousands of dollars which means a good amount of profit for a bank.
Mortgages
Mortgages are some of the most significant loan options a lender can offer. These loans will be for hundreds of thousands and usually mean income for decades.
Student Loans
Private student loans are available through banks, interest rates will be higher than federal student loans. Still, they can help those who do not have access to those federal options. A bank may see revenue for anywhere between five to 10 years.
Credit Cards
Banks may have several different types of credit card options available for existing banking customers and for those who do not have any accounts with them. The good thing about credit cards for banks is that revolving credit can mean revenue for many years, as long as the borrower keeps the credit card account open.
Car Loans
Car loans can be used to finance a car purchase. With a payback period averaging about three years, a bank can definitely make good money by offering car loans.
Can Banks Create Money?
One common misconception that many people have is that all banks have the ability of money creation out of nowhere. That is just not the case; central banks or reserve banks are the only ones allowed to print money. A central bank will try to do this strategically for economic stability.
A Few Other Ways That Banks Earn Money?
When banks extend credit from bank deposits, they make most of their money. However, there are a few other ways that banks make money; here are the two different primary modes of profit for banks and similar depository institutions:
Bank Account Fees
Another way a financial institution like a bank makes money is through different account fees. Most people are familiar with the standard bank account fee you must pay when opening a bank account. On top of that, there may be other fees bank customers will be charged depending on your activity. Here are some standard bank fees that customers face:
Non-Sufficient Funds Fee
A non-sufficient funds fee of NSF fee is charged when a customer doesn’t have enough money in their bank account to make a purchase and doesn’t have overdraft protection in place. Their bank account will then go into negative, which if not taken care of right away can mean additional fees. NSF fees are usually around $35.
An Overdraft Fee
Overdraft protection is a feature that banking customers can add to their accounts. It allows them to spend money even if they don’t have sufficient funds in their bank account. When this occurs, there will be an overdraft fee instead of going into negative. Just like an NSF fee, not paying your overdraft fee can have expensive consequences. Overdraft fees are also around $35.
Bank Account Closure Fees
If a customer has opened their bank account recently, they may be charged a fee for closing it— generally around $25. Usually, this period can be anywhere from 30 to 60 days after opening.
Transfer Fees
There can be fees for multiple transfers between internal and external accounts. These fees average around $35 per transaction.
Investments
Another source of revenue for banks is their investment advice for businesses and individuals. Experts from banks can help you determine the best way to spend your money and help you figure out different money goals with new or existing assets. Wealth management is another service that can fall under this category.
References:
Where Do Banks Get Money to Lend to Borrowers? | Fortunly
