How Financial Institutions (Banks and Credit Unions) Generate Revenue

Banks provide numerous "free" services, such as savings accounts and checking accounts. In fact, they may pay you for leaving your money in the bank, and you can increase your earnings with certificates of deposit (CD) and money market accounts. Unless they are exclusively online, the majority of banks and credit unions have physical locations staffed by employees. Additionally, they operate call centers with extended hours of customer service.

How are all of these services financed? Investments (or borrowing, lending), account fees, and additional financial services generate revenue for banks. When giving money to a financial institution, it is crucial to understand its business model and fees, but it is not always clear how banks are compensated. There are a number of ways for banks to generate income, such as investing customer funds and charging fees.

The Reach

Banks traditionally generate profits through borrowing and lending. Banks accept customer deposits (essentially borrowing the funds from account holders) and lend them to other customers. The mechanics are somewhat more complex, but this is the general concept.

Spend less and earn more: 

Low rates of interest are paid on savings accounts, certificates of deposit, and money market accounts. Typically, they pay nothing on checking account balances. Simultaneously, the bank charges relatively high interest rates on home loans, auto loans, student loans, business loans, and personal loans.

Note

The difference between the low rate banks pay out and the high rate they earn is referred to as "the spread," which is also known as the bank's "margin."

For instance, a bank offers a 1% annual percentage yield (APY) on savings account cash. Customers who obtain auto loans to purchase new cars pay an average APR of 6.27 percent. This means that the bank theoretically earns 5.27 percent on these funds, but it could earn considerably less after accounting for operating expenses. It will earn more with credit card processing. Recent data from the Federal Reserve indicate that the average annual percentage rate (APR) on credit cards is 16.30% as of October 2021.

Investments:

When banks lend your funds to other clients, they "invest" those funds. However, banks do not merely invest by extending loans to their clientele. Some banks make substantial investments in numerous types of assets. Some of these investments are straightforward and safe, while others are complex and risky.

There are restrictions on how much banks can gamble with your money, particularly if your account is FDIC-insured. Nonetheless, these regulations are subject to change over time. Still, banks can increase their profits by taking greater risks with your money.

Accountholder Fees

As a consumer, you are likely familiar with the bank fees that can be assessed to your checking, savings, and other accounts. These fees are becoming easier to avoid, but they continue to contribute significantly to a bank's earnings.

For instance, the Advantage Plus checking account from Bank of America has a $12 monthly maintenance fee. These fees will cost you $144 over the course of one year. You may be able to avoid monthly maintenance fees, however, by maintaining a minimum balance or establishing direct deposit.

Additionally, banks charge fees for certain account-related actions and "mistakes." If you have overdraft protection, it will cost you approximately $30 each time you overdraw your account. Even if you opted out, you are still obligated to pay these fees. You bounced a check, right? That will cost you as well. There is a long list of account-related fees and charges, including but not limited to the following:

• ATM charges (including fees that the bank charges, and the fees from the bank that owns the ATM)

• Replacement of a lost or stolen (and extra charges for rush delivery)

• Early withdrawal from a certificate of deposit

• Prepayment penalties on loans

• Late payment penalties on loans

• Inactivity Fees

• Fees for paper statements

• Fees for speaking with a teller if you have a low-cost online account

• Requests to stop payments

Service Charges

In addition to earning income from lending and borrowing, banks also provide optional services.

Note

There are numerous bank customers (individuals, businesses, and other organizations) who pay for these services.

There are variations among banks, but the following are some of the most common services:

Credit Cards: 

You are already aware that banks charge interest on loan balances and may charge cardholders annual fees. In addition, they earn interchange revenue or "swipe fees" whenever your card is used to make a purchase. In contrast, debit card transactions generate considerably less revenue than credit card transactions. Because of this issue, merchants prefer that you pay with cash or a debit card, and some stores even pass on these fees to customers in the form of credit card surcharges.

Checks and Money Orders: 

For significant transactions, banks issue cashier's checks, and many also offer money orders for smaller items. Typically, these instruments cost between $5 and $10. Even though you can reorder personal and business checks from your bank, it is typically less expensive to do so online through a check-printing company.

Wealth Management: 

In addition to standard bank accounts, some institutions provide wealth management products and services through financial advisors. These activities supplement bank profits with commissions and fees, including fees for assets under management.

Payment Processing: 

Banks frequently process payments for large and small businesses that wish to accept credit cards and ACH payments from their customers. Monthly and transaction-based fees are typical.

Positive Pay:

If you're concerned about counterfeit checks printed with your business account information, you can pay a fee to have the bank monitor all outgoing payments before they're authorized.

Loan Fees:

Depending on your bank and the type of loan, you may be required to pay an application fee, an origination fee of approximately 1 percent, discount points, and other fees in order to obtain a mortgage. These fees are paid in addition to the interest on the loan balance.

Note

Some credit unions offer similar interest rates and fees as conventional banks, so the difference in structure is merely a technicality.

How the Credit Unions Works

Credit unions are customer-owned financial institutions that operate similarly to banks. They provide comparable products and services, charge comparable fees, and invest deposits by lending to or investing in the financial markets.

Because credit unions are tax-exempt and customer-owned, they are sometimes able to pursue less profit than conventional banks. They may pay more interest, charge less on loans, and invest with greater caution.

Frequently Asked Questions (FAQs)

What do credit unions do with their profits?

Profits are returned to members, who are also owners, in the form of increased savings rates, decreased loan rates, and reduced fees.

How much profit do banks generate?

In the first quarter of 2022, banks earned $59.7 billion, a decrease of 22.2% from the first quarter of 2021. According to market, economic, and political conditions, bank profits fluctuate.