Most of us use a variety of services provided by banks, but do we know how banks make money. Probably you do not know how they generate revenue. So, if you want to know how banks earn profit in different ways. Then stay on this blog and scroll down to get the information about the same.
This blog will help you to gain information on how the banks work and generate their revenue to keep it functional for the long term.
How Do Banks Work?
Before learning about how banks make money, let’s understand how banks work first because it will help you digest further information easily. Generally, banks receive or borrow cash or money from their customers or you at a lower interest rate and then lend to others at a higher rate of interest. And from the difference of these two is the which is the surplus amount they earn as revenue. Every bank follows the same strategy they borrow money and lend it to another person, business, financial institution, and any other organization.
How Bank Earn Profit?
There are plenty of sources banks earn money from, and here we will learn about these sources. Some of the methods you may know already, but some may sound new, so let’s look at these sources of income for the banks.
1. Net Interest Margin Method
It is one of the commonly used methods that every bank use, as we have discussed above. It is the primary source of income from every bank; they use their customers borrowed money by providing a certain amount of interest. Generally, banks provide around 4 percent interest on saving accounts and around 6 percent interest on fixed deposits.
On the other hand, the banks lend this money to the people, organizations, and other businesses with higher interest that can be 9 percent to 15 percent. With the help of this method, banks gain 4to 11 percent income; this method is also known as the net interest margin method.
Importance of Interest Income for Banks:
You may be willing why banks charge interest income from their customer or why they love this method of making a profit. So, here I will try to explain with you here at this part of the blog.
- Here banks can set their interest rate.
- It is one of the primary earning sources for the banks
- The central bank decides the interest rate to control inflation and keep the economy healthy.
- Banks need to pay a lower interest rate to the depositors.
- Therefore it is an easy and efficient source of getting or borrowing money.
2. Income from Standard Fees
Banks also make money from the fees for services they provide. These services can be bills of exchange, syndication of loans, debit card fees, transaction charges, and more. For example, if you have an XYZ bank account, you may be using some services. Like transacting cash, making payments, taking ATM card service, or using cheque. So for these services, banks charge a nominal fee which is easily payable by the user or the customer. Fee-based incomes are one of the stable sources of income for the banks because they keep charging from the customers consistently from their respective accounts.
3. Income from Investment
Banks also invest in a wide range of government and top securities to generate income in interest, dividends, and profit. It is also becoming one of the good sources of income for the banks. These days, banks also invest in small to medium companies to help them grow and generate a reliable income source. This method is different as banks do not lend the money but buy the share, stocks, bonds, or other marketing securities on behalf of their bank.
4. Income from Capital Market Related Services
Banks provide capital market-related services to investors and corporations to make the investment procedure simple. Capital markets are one of the essential marketplaces that affect the economy too. Here businesses get sufficient funds to grow their business or project with the help of investors. They borrow a certain amount of capital from the potential investors and return them a fixed or fluctuated rate on their capital.
Nowadays, banks are providing sales and trading, M&A advisory, and underwriting services for their customer. And in return, they charge small fees or charges from the customers. Banks offer brokerage services from their in-house experts. Along with this, they also offer a dedicated team to plant financial investment plans for the investors. Now, most banks offer M&A or mergers and acquisitions services to simplify this process.
5. Matter of None Non-Performing Assets
When banks lend their customer’s money to businesses and people, there are higher chances that these borrowers will not pay in the future. Therefore, in those cases, banks have to settle with their customers from their funds, which can be costly. The non-performing asses are the assets of defaulters or the loans borrowers default. Now, most of the banks are developing good credit models to analyze the creditworthiness of the borrowers to reduce such amount of cases.
Conclusion
Banks are essential parts of the financial industry because they fill the gap between borrowers and depositors. They offer a wide range of banking and financial services to borrowers and depositors to keep them satisfied. Therefore, Banks make money from vast sources such as interest income, fees income, and other income from direct sources. However, banks also earn money from their investments and various capital marketing services. Sometimes banks also have to face defaulters who do not pay their loans and default. Thus, banks need the innovative and latest technology to improve efficiency in banking activities to make them more reliable and smooth.
So, in this blog, you have gained information about how banks earn profit or money from various sources. If you like this information and find it valuable, then share it with your friends to make them aware as well. You can also feel free to comment down below to let us know which of the banks’ methods you already knew.