Here's what Banks Do with Your Money

How does a Bank Make Money?

      Everyone deposited cash into the bank at one point. Or even borrow money for a real estate loan. But have you known much about what the bank does with the money after you put it in a savings account? Have you ever thought about where the money for your home loan comes from?

A bank is a financial institution that has a license to accept deposits of money and provide loans. (investopedia)

Some bank accounts charge you a monthly fee, but in return, you may get cashback, travel insurance, or a higher interest rate. But for many, an account doesn't cost anything upfront.

This might seem clear. Somehow, it's your money there, then why should you pay to get it? But this was not always the case, 'free charge banking only arrived in the UK in the 1970s, and in many other countries it is common to pay for withdrawals or pay a monthly fee.

The Way Banks Make Money

Your bank deposit is only a little part of the game. Although today's banks are large, complex, and highly diversified, these financial institutions still generate most of their income in 3 methods:

Interest income

Banks earn income from interest payments that borrowers make when they repay loans. This is where the money deposit comes in, but not in the way you might think.

Capital markets income

Banks raise cash through the capital markets, by offering services such as mergers, underwriting, acquisition advisory, and sales services.

Fee-based income

Banks make money by charging a variety of fees, many of which you know, and probably hate, related to their products and services, including current and savings accounts, mutual fund income, credit card, custodial, and investment management fees.

Banks make a lot of money charging interest on loans, but the fees that banks convert are just as profitable.

- Bank account fees

Several certain financial products that charge fees are checking accounts, credit cards, and investment accounts. This fee is referred to as a "maintenance fee" even though the cost of maintaining a bank account is relatively small.

- ATM fees

There will be times when you can't find your bank's ATM, and you'll have to settle for another ATM just to get the money. That’s perhaps going to charge you $3. Situations like that happen all the time, and just mean extra money for the bank.

- Commissions

Some banks will have an investment division that often functions as a full-service broker. Of course, their commission fees for making trades will be higher than most discount brokers.

- Application fees

Every time you apply for a loan (especially a home loan), many banks charge a loan fee or application fee. And, they can take the freedom of putting this amount in the principal of the loan, which means you'll also be paying the interest.

Banks use Your Money to Make Their Income

Every time you make a deposit, the bank essentially borrows some of that cash from your account, and lends it to other borrowers, whether it's a personal loan, a car or home loan, or credit.

Do you remember that time you took out a loan from the bank? The cash you borrow from the bank is taken from the deposits of other customers. The interest you pay on the loan balance is added as a perfect source of income for the bank, part of which is paid back to the depositor.

Also, deposits from savings accounts, certificates of deposit, money market accounts, etc., are used to fund loans for other people, and the interest they pay back becomes part of the interest you will earn on your savings account. Technically, you lend cash to your bank, and they pay it back, with interest, just like any other loan.

But because banks are in the business of making money, they will never pay more interest than they can charge. A high-yield savings account can earn you up to 1.25% APY interest, for example, but the bank may charge a 5% fee on the loan (maybe higher, depending on the loan). meaning that the amount they give back to the customer is only a fraction of what they could potentially earn as a whole.

The wider the deviation between interest rates, the greater the profit earned by the bank. For example, a bank may charge its current lowest deposit rate, 0.06%, but charge an 18% interest rate on one of its credit cards. The interest they pay is very much in line with what they can earn from lending cash. So if you deposit $5,000 into a savings account, you might gain a 1.00% interest rate, but the bank can lend most of that fresh funds at a much higher rate, enough to make a profit and pay your interest.

How Banks Prevent You from Withdrawing Your Money at Once?

All savers may want to withdraw their cash at the same time, in which case, the bank will have to ask the mortgage borrower to repay their money immediately.

Banks have the potential to go bankrupt, so to avoid this scenario, banks give higher interest rates to people who are willing to put their money into bank savings accounts with a notice period.

If people want to get their money back, they have to make a notification letter before they can withdraw it.