Everyone knows banks to be financial institutions where money enters and leaves at will. The general idea is that there is always money in the bank.
Well, this may be true. However, have you ever wondered how these traditional banks make their money? For one, you can say it is from printing the money and ensuring there is a portion that goes to every bank in the country. Another argument is that maybe customers make deposits and fund the overall account of the institution.
These arguments are not also entirely wrong, but if you need to be more precise about how traditional financial institutions make their money, you need to look deeper. For instance, if you say customers make deposits, how about those who withdraw? Also, there is a specific amount of money that the Treasury/Central Bank prints out every year. So, how do these places make money?
In this article, you are about to find out how customers contribute largely to the revenue income of traditional banks.
What Are The Types of Banks
Generally, there are two types of banks – the Commercial Bank and the Central Bank.
- Commercial Bank
It is a financial institution allowed to take deposits, offer withdrawals, and provide several other banking services to customers. It is the regular/traditional bank you see around, providing loans with interests to customers.
- Central Bank
This is a financial institution that supersedes commercial banks. It gives directives as to how commercial banks should operate. It also takes up the responsibility of printing money.
For the purpose of this article, we would be focusing on commercial banks.
How Do Commercial Banks Operate?
Commercial banks usually offer merchant services that is why you have it easy to make deposits and withdrawals even electronically. They even provide the manual teller and automated teller machines (ATMs) services to process transactions faster and quicker. No one wants to stay in the bank for long hours anymore.
Additionally, they provide lending and investment services to customers. You can get loans and mortgages from this traditional institution to support your education, housing, and finances. You can even open lines and letters of credit, just as long as you are eligible for one.
And in the case of an emergency, you could book an appointment with a customer representative or an account officer to solve your problems. Overall, they serve as the custodian of your finances, ensuring that you get to access money whenever and wherever, as long as you have met all requirements.
How Do Commercial Banks Make Money?
It shouldn’t be too hard to figure out that it is a ‘give-and-take’ situation with commercial banks. While they provide you with numerous services that allow you to keep banking with a favorite institution, you are paying them back and contributing to their revenue income. Below are ways traditional institutions make money off its customers.
- Interest Rates Income
Once interest is mentioned, you know for sure that there is a percentage of money you would have to pay to the other party. Well, commercial banks started this and it is one of the popular and main ways they make money. Now how does this work:
Banks take out money from a depositor’s account and compensate them with a significant interest rate while providing good security for funds. This money is then lent to borrowers who have to repay the money at a higher interest rate. Once this has been paid, the bank settles the depositor and holds onto the remaining balance.
- Service Charges and Fees
Another way commercial banks make money is through service charges and fees. Maybe at one point or another, you may have found an amount of money deducted from your account with a certain description – for example, “account maintenance fees.” These are service charges that the bank claims to use to keep your account open and active.
Other examples include ATM fees – for in case you use another bank’s ATM, and overdraft fees – when you exceed your account’s overdraft. You might also have to pay additional fees for international transactions conducted through your bank – for instance, if you buy cryptos in a crypto casino through your bank, you will have to pay processing fees.
- Credit Card Fees
Still speaking about fees, credit cards are one of the smartest tricks that commercial banks have pulled to generate revenue. The concept is to loan people an amount of money and ensure that they pay back within a billing cycle. However, if you don’t pay this money, you will be forced to pay an interest rate higher than usual – often between 15 to 25%.
Apart from late payment fees, banks receive interchange fees from merchants for every transaction you make with your credit card. It isn’t as high as the other types of fees, but it could be a source of passive income if it comes from multiple sources.
- Foreign Exchange Service
While international transactions are sources of revenue for commercial banks; foreign exchanges are another. This is a situation where if you have to convert one currency to another, it would be at the bank’s rate, and a service charge will apply. The fee may be small from your end, but take it from over 1000 people in a day and that’s enough money for the bank.
- Mortgaged Securities
Mortgaged Securities or Mortgage-backed Securities is another profitable means for commercial banks. It usually involves the financial institution selling mortgages as securities to various investors. During this process, an upfront payment is received, which is in turn used to support the bank’s lending services.
Conclusion
So, are you surprised that you are responsible for keeping commercial banks running? Without customers opting for lending services, paying charges and fees, or depositing funds, traditional banks would just be as unimportant. They rely on these revenue streams and this also supports the overall economy of a country. As new technologies emerge, these financial institutions often look for ways to provide better services to their customers – and of course, make money for themselves!