Banks work like almost every other business, they are selling a product or service. Banks actually do both. They offer a secure place to park your money and they also sell money (loans).
Although they are becoming harder to find, there are still institutions that offer free checking accounts or even interest-bearing checking accounts. Have you ever wondered how banks can afford to pay YOU and still make money?
A bank’s three main sources of revenue are: Fees, Net Interest Margin and Interchange. Here is a brief explanation of each…
This is a fairly new way that banks have devised to make money, starting about 1996. Although laws have been passed trying to reign in those fees, most of them haven’t been very successful. A federal law in 2010 says that you, the consumer, must agree to overdraft charges when you sign those papers at the bank to create an account. Of course, like TOS, if you don’t agree, you don’t get an account.
Back in 2015, the top 3 banks alone made $6 Billion from overdraft and ATM fees alone. This doesn’t include late payment fees on credit cards. This $6 billion accounted for as much as 20% of the bank’s revenue. It’s easy to see why banks fight so hard to prevent laws limiting their use of fees and other charges.
Net Interest Margin
This isn’t as complicated as the name sounds. When you deposit money at your bank, you are essentially giving the bank permission to use your money to make loans or earn interest. The bank loans out money to others (such as mortgage loans or car loans), who pay it back with interest. Banks will pay you a small percentage of interest on your money and they keep the rest. The difference between the amount of money a bank earns via interest charges and the amount that the bank pays you is called net interest margin.
Unless you are a billionaire, you could withdraw all your cash from the bank today and they would be able to cover it with no problem. How? Because every bank has what is known as a reserve requirement. This amount is set by the federal government.
Every time you use your credit or debit card at a store, the store pays a small fee, known as an interchange fee. While the store, or merchant, gets a small fraction of this back, the majority of it goes to the bank.
This is how banks can afford to offer you those incentives or rewards for using their cards. They simply charge higher interchange fees when those cards are used. Banks often charge annual fees for owning those cards as well, which earns them more $.