How Does A Bank Make Money?

How does a bank make money? Banks make money in several different ways; the most common way is through making loans. In today's world, what we call a bank is a financial institution that provides financial...

In today's world, what we call a bank is a financial institution that provides financial services. It receives a banking license from regulatory authorities to receive deposits and grant loans. Banks make money in several different ways; the most common way is on making loans. "Banks make money when the income from loans to customers exceeds the interest paid to depositors," says Sharon Lee, the Executive Vice President and Director of Client Services of American National, a thirty-year veteran of the banking industry.

Along with offering loans, banks offer certificates of deposit and other financial instruments. The interest that people pay is where the bank gains some of its profits. One of the jobs of the Federal Reserve, or the Fed, is to set interest rates. When a person goes to a bank to get a loan, they sign paperwork stating they will repay the money at a certain interest rate. This interest rate is higher than the federal rate. The difference is where a bank makes money.

Certificates of Deposit or CDs work similar to loans except you are paid to let the bank use your money to loan to other people. A difference in the two rates is the profit margin. Banks rate how risky a loan by the probability of being repaid. A high-risk loan will have a higher interest rate, potentially leading to higher returns for them.

Another way that banks make money is from fees that customers pay for services. "Service charges and fees are another important source of income as is the income from invested funds. The income made on loans and the other fee income is used to cover all expenses such as occupancy, staffing and systems," says Sharon Lee.

A common fee charged is to maintain a checking account. The amounts vary from bank to bank and even within the same bank depending on the type of account. Some banks will waive the fee if you keep a certain balance in your checking and savings accounts. If you 'bounce' a check, meaning the check goes to the bank to be paid and there is not enough money in the account to cover the charges, you will be charged for insufficient funds. A normal range for insufficient funds is between $20 and $35 per transaction.

Banks also make money from automated teller machines or ATMs. Withdrawing money from an ATM that is not part of your bank's network will typically result in an 'out-of-network' fee that can be up to $2.50. In addition, the bank owner of the ATM you used may also charge you a fee for use of their equipment, again up to $2.50 or more.

One of the newer fees that banks are using is called the courtesy overdraft. If a check comes to your account and there is not enough to pay it, the bank will go ahead in most cases and honor the check. In return, they charge you a set amount along with being paid back within a set period. Many of the larger banks provide this service without having the customer sign up.

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