Banks earn money by taking it from savings and checking accounts of their customers and lending to other customers who pay higher interest rates. Other sources of banks’ profit are interchange and banking fees that help to cover the cost of major services.
Explanation:
Banks make most of their money on saving or checking accounts of their customers. Once you deposit money, the bank can invest it in providing loans in different forms, such as mortgages, student or car loans, or credit cards. The interest rate is the additional sum that people or businesses have to pay monthly or yearly to get the loan, and it is calculated as the percentage from the total credit sum. The interest rates comprise the majority of banks’ revenue. Some part of this sum is then paid back to the owner of the checking or savings account as his deposit interest. The difference between those rates is the actual profit of the bank, which is called the Net Interest Margin (NIM).
For example, one client deposits $10,000 with a yearly interest rate of 3%. Another client gets a car loan on the same sum, with an interest rate of 7%. At the end of the year, he or she has to pay $10,700 back to the bank, while the bank increases the customer’s account to $10,300. The bank gets the Net Interest Margin of $400, which illustrates how much money banks can make from $10,000 in a year. This ratio can vary, and it indicates how successfully the banks invest your money.
Several factors influence the level of interest rates both on loans and deposits. The developing economies generally show the increased demand for money, which elevates the interest rates. The supply of money that banks can invest has a substantial impact on the deposit rates too. If the supply is low, banks need to attract more customers, and thus they offer high interest rates for deposits. If a particular bank has an extensive money supply, the rates for the savings accounts are likely to decrease. For example, Swiss banks are famous for their safety and stability, so many people from around the world prefer to store their money there. Thus, Switzerland has one of the minimum deposit rates that are sometimes even zero percent. The rates in the US banks are also influenced by the Federal Reserve policies that increase or decrease the rates to regulate the economy. Such factors as inflation or international exchange rates also impact the percentage paid for loans or deposits.
Banks highly depend on the external economic factors, so it is a business of high risks. It is evident that banks make money from deposits, but when a substantial part of them is withdrawn, or people tend to borrow more money than save, banks get a negative NIM. This means that they lose more money than earn, and if the situation is not handled rapidly, they can reach bankruptcy. Fortunately, the deposits in the American banks are insured by the Federal Deposit Insurance Corporation (FDIC), which means that the customers will be able to access their money even if something happens to their bank.
Although NIM is the most substantial source of banks’ income, there are other ways for how banks earn their money, including banking and interchange fees. The latter is charged when a customer uses a debit card to pay at the store or other merchandise. This sum is mostly utilized for covering all the service expenditures for the banks. Customers also pay the fees when they use banking services such as ATM withdrawals or replenishment of the card with cash. Although these fees are not generally high, they can account for 5 to 20 percent of banks’ profit.