How do banks make money?
You know that Banks lend you money and keep your funds secure. But, have you ever wondered
How banks make money?
Banks are like any other business, and their product is money. Banks primarily earn money through two avenues- the interest they charge on the money they lend you and the fees they charge for their various services like checking, ATM access, overdraft protection etc.
In this article, we will take a close look at how banks make money in India-
How do banks make money?
The answer is fairly simple. Banks mostly make money through two core avenues- commercial and investment banking. Commercial banking deals with accounts and mortgages, whereas investment banking deals with corporate transactions and wealth management. The money banks earn for providing these services are categorised under Interest income, Fee income and Other Income. Below is a detailed look at how banks generate revenue in these areas.
You know how banks pay you lower interest rates when you deposit money with them and charge higher interest rates when they give you a loan? The income banks earn by doing so is called the Net Interest Income (NII).
The margin or the spread between these two interest rates is called the Net interest margin (NIM. In commercial banking, this is what primarily generates revenue for the organisation. The NIM is a key profitability ratio. Typically NIM is higher when interest rates are high and falls when interest rates go down.
Banks also charge a wide range of fees for many of their services. These include-
Whenever you make a transaction during a purchase using a particular bank's credit card or debit card, an interchange fee is charged to the merchant's bank. This is also known as "swipe fees" and is a significant source of bank income.
Customers are allowed a certain number of transactions from the ATM of a bank. After crossing that limit, they must pay a certain fee to conduct transactions.
Minimum balance fees
Usually, banks require a particular minimum balance amount for various accounts. If the balance goes below that amount, then the account holder has to pay a fee in the form of a fine.
Late payment fees
A fee is levied on customers who miss payment deadlines to clear their credit card dues. This charge varies from one bank to another.
Wealth management fees
Banks charge a specific fee for handling your investments and other related services. This falls under-investment fees.
Banks also often charge an origination fee while lending money. This acts as a great source of revenue for banks.
If your account balance falls below zero, then an overdraft fee is charged to the account. The bank can levy interest on the overdrawn amount as it can be seen as a short-term loan.
Other account fees
There are many things the bank charges you money for. Some standard fees, except those already mentioned, are non-bank ATM withdrawal fees, international debit card transaction fees, fees for money orders and cashier's checks, and wire transfer fees.
Apart from the above sources, banks make money in some additional ways. They are-
Interest on investments
Many banks invest in government and other rated securities, which generate significant interest and revenue for the bank.
In foreign exchange operations, banks act as brokers and generate income for the institution.
Commission earned on third-party products.
Banks earn a large commission by distributing insurance products and mutual funds to their customers
Capital markets-related income
Many banks provide capital market-related services to their customer base. The capital market is where businesses that require capital or funds are matched with investors who want a return on the capital provided. Banks have in-house brokers who facilitate these trades. The banks might also offer services like assisting in debt and equity underwriting, mergers and acquisitions, IPOs etc., and they charge a substantial fee for these services.
This is a volatile source of income for banks as it depends on capital market activity.. In times of economic recession, banks need help generating income through this source.
To conclude, not all banks earn money through all the sources named above. Some banks may only make money through interest income and fee income. Banks that have a strong investment banking arm are those that earn a significant share of their revenue from other income sources.
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