How do banks make and lose money?
They make money from what they call the spread, or the difference between the interest rate they pay for deposits and the interest rate they receive on the loans they make. They earn interest on the securities they hold.
Commercial banks make money by providing and earning interest from loans such as mortgages, auto loans, business loans, and personal loans. Customer deposits provide banks with the capital to make these loans.
Banks are financial intermediaries that accept deposits, make loans, and provide checking accounts for their customers. Money is created within the banking system when banks issue loans; it is destroyed when the loans are repaid.
If you don't know the business model of banks, you may be wondering if they're seeing any profit on their end. While it may not be obvious, banks can't make money without having your money first. There are two ways that banks can actually make a good profit from your free checking account: loans and fees.
The primary way that banks make money is interest from credit card accounts. When a cardholder fails to repay their entire balance in a given month, interest fees are charged to the account.
Whether you put all of your eggs in the basket of traditional services like checking and savings accounts and loans, or whether you offer a broader financial services portfolio, most banks yield about 10-15% net profit, with 7-10% return on investment or equity.
Banks can create money through the accounting they use when they make loans. The numbers that you see when you check your account balance are just accounting entries in the banks' computers. These numbers are a 'liability' or IOU from your bank to you.
“If a bank assumes too much risk in its investments or loan portfolio and realizes its losses, that could be a cause of the failure,” Meyer says. “If no additional capital is raised and the losses are severe enough, the regulators will assume the institution to sell or liquidate it.”
Banks carry higher amounts of debt because they own substantial fixed assets in the form of branch networks. The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear.
Keeping large amounts of money in a bank can be tricky, but it is possible. There are limits to the amount of money that is insured for each depositor at a bank — up to $250,000 per depositor per account category with the FDIC — so the super wealthy often spread out their accounts over multiple banks.
How do banks make money if they don't charge fees?
They make money from what they call the spread, or the difference between the interest rate they pay for deposits and the interest rate they receive on the loans they make. They earn interest on the securities they hold.
That being said, a bank needs to have access to liquid reserves to create money. In other words, a bank can't just conjure infinite amounts of money. Plus, the deposit that is created needs a certain amount of reserves to be held against it, which is supplied by the Federal Reserve (the U.S.'s central bank).
Answer: Checking accounts provide banks with a cheap source of funds (they pay almost no interest on them) that they then loan out at much higher interest rates.
If the bank decides you're a deadbeat, the financial statements can't ignore that. Ignoring the bad debt would give investors and auditors a distorted view of the bank's health. Instead, the accountant writes off or charges off your debt – they mean the same thing – to remove the $100,000 from the balance sheet.
Making loans
The process involves maturity transformation—converting short-term liabilities (deposits) to long-term assets (loans). Banks pay depositors less than they receive from borrowers, and that difference accounts for the bulk of banks' income in most countries.
Commercial banks make money by providing and earning interest from loans [...]. Customer deposits provide banks with the capital to make these loans. Traditionally, money earned in the form of interest from loans often accounts for up to 65% of a banks' revenue model.
OneUnited Bank is the nation's largest Black-owned and FDIC-insured bank. It was established by combining Black-owned banks from across the country.
| State | Annual Salary | Monthly Pay |
|---|---|---|
| California | $78,777 | $6,564 |
| Louisiana | $78,602 | $6,550 |
| Pennsylvania | $78,576 | $6,548 |
| Nebraska | $78,194 | $6,516 |
If so, provided that you have enough money, a good business plan and the patience to make it through the regulatory process, you could actually start your own bank. Plenty of people have, over the years.
At the moment of deposit, the funds become the property of the depository bank. Thus, as a depositor, you are in essence a creditor of the bank. Once the bank accepts your deposit, it agrees to refund the same amount, or any part thereof, on demand.
Who do banks borrow money from?
Banks can borrow at the discount rate from the Federal Reserve to meet reserve requirements. The Fed charges banks the discount rate, commonly higher than the rate that banks charge each other.
Every time a dollar is deposited into a bank account, a bank's total reserves increases. The bank will keep some of it on hand as required reserves, but it will loan the excess reserves out. When that loan is made, it increases the money supply. This is how banks “create” money and increase the money supply.
Banking regulation has changed over the last 100 years to provide more protection to consumers. You can keep money in a bank account during a recession and it will be safe through FDIC and NCUA deposit insurance. Up to $250,000 is secure in individual bank accounts and $500,000 is safe in joint bank accounts.
If your bank fails, up to $250,000 of deposited money (per person, per account ownership type) is protected by the FDIC. When banks fail, the most common outcome is that another bank takes over the assets and your accounts are simply transferred over. If not, the FDIC will pay you out.
As a bank run progresses, it may become a self-fulfilling prophecy: as more people withdraw cash, the likelihood of default increases, triggering further withdrawals. This can destabilize the bank to the point where it runs out of cash and thus faces sudden bankruptcy.
