How Do Banks Make Money? Key Revenue Streams Explained
Discover how banks generate revenue through lending, fees, investments, and services, balancing risk management with customer financial needs.
Banks are often seen as safe places to store money, but they are also businesses focused on generating profit. Understanding their revenue sources is helpful because it clarifies why certain fees exist, how interest rates affect consumers, and what drives many financial products. Since banking services are integral to daily life, knowing how banks earn income can empower consumers to make more informed financial decisions.
This article outlines the primary ways banks make money, providing insight into the activities contributing to their profitability.
Lending Income
A principal source of bank revenue is lending. Banks provide funds for various needs, including home purchases (mortgages), car buying (auto loans), business operations (commercial loans), and personal expenses (personal loans). They act as intermediaries, using customer deposits to fund these loans. Profitability arises from the difference, or spread, between the interest rate charged to borrowers and the rate the bank pays for its funds (like deposits).
This difference generates Net Interest Income (NII), calculated as the interest earned on loans and other assets minus the interest paid on deposits and borrowings. NII is a cornerstone of income for most banks. Analysts often assess profitability using the Net Interest Margin (NIM), which compares NII to the bank’s average earning assets, expressed as a percentage.
Loan interest rates vary based on factors like loan type, duration, and the borrower’s perceived risk. Underwriting is the process banks use to assess this risk, evaluating an applicant’s credit history, income, debts, and assets to gauge repayment ability. For secured loans like mortgages, the value of the collateral (the property) is also appraised. This review helps manage credit risk—the chance a borrower might default.
Effective credit risk management is essential for lending profitability. Banks use underwriting standards and often diversify their loan portfolios across different loan types, industries, and regions to reduce potential losses. Regulatory agencies, including the Federal Reserve, the Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC), oversee bank lending practices, setting guidelines for fair lending, capital adequacy, and risk management to ensure the stability of the banking system.
Deposit-Related Fees
Banks also earn significant non-interest income through fees associated with deposit accounts, like checking and savings. These fees cover service costs and contribute directly to profits. Federal law requires banks to clearly disclose all potential account fees.
Common charges include monthly maintenance fees, often waived if customers meet conditions like maintaining a minimum balance or setting up direct deposit. Overdraft fees are another major source, charged when a customer spends more than their available balance and the bank covers the transaction.1FDIC.gov. Overdraft and Account Fees These fees can be substantial and accumulate quickly.
Distinct from overdrafts are non-sufficient funds (NSF) fees, charged when a bank returns a payment unpaid due to lack of funds. Unlike an overdraft where the bank pays the item, an NSF fee is for rejecting it. Using ATMs outside the bank’s network can also incur fees from both the customer’s bank and the ATM owner.
Other potential fees include charges for:
- Wire transfers
- Paper statements
- Ordering checks
- Stopping payment on a check
- Closing an account soon after opening
- Account inactivity
- Replacing a lost debit card
Regulations govern these fees to ensure transparency. The Truth in Savings Act requires clear disclosure of account terms, including fees and interest rates.2Consumer Financial Protection Bureau. 12 CFR Part 1030 – Truth in Savings (Regulation DD) Regulation E requires consumers to affirmatively “opt-in” before banks can charge overdraft fees for covering most ATM and one-time debit card transactions; otherwise, the transaction is typically declined.3NAFCU Compliance Blog. Overdraft Protection: Members Affirmative Consent and Opt-in Confirmation The Consumer Financial Protection Bureau (CFPB) oversees compliance and addresses unfair fee practices.
Credit Card and Merchant Services
Credit card operations provide substantial income through interest charges and fees. Banks earn interest when cardholders carry balances month-to-month, often at high Annual Percentage Rates (APRs). Regulation Z, implementing the Truth in Lending Act, mandates clear disclosure of these rates and terms.4National Credit Union Administration. Truth in Lending Act (Regulation Z)
Banks also collect various fees directly from cardholders, such as annual fees (especially for rewards cards), late payment fees, and foreign transaction fees. The Credit Card Accountability Responsibility and Disclosure (CARD) Act of 2009 introduced consumer protections, limiting certain fees and requiring advance notice for rate increases.5Congress.gov. H.R.627 – Credit CARD Act of 2009
A significant, less visible revenue stream is interchange fees. Each time a credit card is used, the merchant’s bank pays a fee to the cardholder’s bank (the issuer).6Richmond Fed. The Role of Interchange Fees on Debit and Credit Card Transactions Set by networks like Visa and Mastercard, this fee compensates the issuer for processing costs and risks. While the Durbin Amendment capped debit card interchange fees for large banks, these caps do not apply to credit card fees.
Many banks also generate income through merchant services, enabling businesses to accept card payments. Banks acting as acquirers charge merchants a fee, often called the Merchant Discount Rate (MDR), for processing transactions. This rate typically includes the interchange fee, card network assessments, and the acquirer’s own processing fee.
Revenue from merchant services can also come from monthly statement fees, charges for point-of-sale (POS) equipment, and fees related to Payment Card Industry Data Security Standard (PCI DSS) compliance—a set of security rules for handling card data. Providing these services helps banks deepen relationships with business clients and cross-sell other products.
Investments and Trading
Banks engage in investment and trading activities, contributing to revenue within regulatory boundaries. A large portion of a bank’s assets is often held in an investment securities portfolio, typically including government bonds and other investment-grade debt. Banks hold these securities to manage liquidity, generate interest income, meet collateral requirements, and manage interest rate risk. Interest earned contributes to NII, and gains or losses from selling securities impact earnings. Regulators set rules on the types and quality of securities banks can hold.7Electronic Code of Federal Regulations. 12 CFR Part 1 – Investment Securities
Banks also earn income through trading. This includes market-making, where the bank facilitates client trades by quoting buy and sell prices for securities, profiting from the bid-ask spread. Banks might also trade for their own account (proprietary trading), seeking profits from market movements using the bank’s capital.
However, proprietary trading is significantly restricted by the Volcker Rule, part of the Dodd-Frank Act. This rule generally prohibits larger banking entities from engaging in short-term proprietary trading to prevent excessive speculation with potentially insured funds. Permitted activities include market-making, hedging, and trading certain government securities under strict compliance rules. Smaller community banks are often exempt.
A bank’s treasury department manages overall financial risks like liquidity and interest rate fluctuations, using the investment portfolio and derivatives primarily for stability rather than speculative profit. While effective treasury management can indirectly boost profitability by minimizing costs or hedging losses, its main focus is risk mitigation and compliance.
Advisory Services
Providing advisory services is another source of non-interest income for banks, leveraging their expertise for fees. Wealth management offers financial planning and investment management to clients, often charging fees based on a percentage of assets under management (AUM).
Trust services involve managing assets according to trust documents or wills, acting in fiduciary roles like trustee or executor. Banks earn fees for these services, which require regulatory approval (like from the OCC for national banks) and adherence to standards preventing conflicts of interest, such as those outlined in the OCC’s Regulation 9.8Office of the Comptroller of the Currency. Comptroller’s Handbook: Personal Fiduciary Activities
For corporate clients, banks advise on major transactions like mergers and acquisitions (M&A) and raising capital through stock or bond issuance (underwriting), charging fees for strategic guidance.
When providing investment advice, bank personnel face specific conduct standards. Investment advisers operate under a fiduciary duty, legally requiring them to act in the client’s best interest, as mandated by the Investment Advisers Act. Broker-dealers recommending securities must comply with the Securities and Exchange Commission’s (SEC) Regulation Best Interest (Reg BI), requiring them to act in the retail customer’s best interest at the time of the recommendation. Compliance is overseen by the SEC and the Financial Industry Regulatory Authority (FINRA).