We all know that banks have a lot of money— but how, exactly, do they make it? How do financial institutions use the money we put into savings accounts? How much do banks profit? Is there such a thing as a not-for-profit bank?
These are all questions that bank account holders may find themselves asking from time to time. It’s reasonable to wonder how these large corporations grew into multi-trillion-dollar entities when you only pay a few bucks a month for a checking account.
In this article, we’ll examine how different types of financial institutions make their money.
Types of Financial Institutions and How They Make Money
Not every financial institution operates in the same way. The following is a look at how different types of banks make their money.
Central banks are the financial institutions that are responsible for managing the monetary system and policy of a country. In the United States, our central bank is the Federal Reserve Bank— commonly referred to as the Fed.
While consumers don’t interact directly with the Fed, they are worth mentioning because other financial institutions do. The Fed sets interest rates on loans and bonds, which affects how expensive it is to borrow money. They raise or lower the interest rate to fight or encourage inflation; their goal is to keep inflation at 2%--enough to keep the economy progressing, but not so much that the price of goods and service starts to spiral out of control. (Want to learn more? Check out our article on inflation.)
How do central banks make money?
Central banks make their money by literally creating it. The Fed is in charge of controlling the money supply, which means they can order more money to be printed. Additionally, the Fed makes money by purchasing securities on the open market.
Retail and Commercial Banks
Retail and commercial banks are probably what you think of when you hear “bank”. These work directly with consumers and businesses to provide things like savings accounts, checking accounts, loans, and more. Banks can be smaller, but 50% of all banking assets in the United States are held by four mega-corporations: JPMorgan Chase, Bank of America, Wells Fargo, and Citigroup.
These big banks are in the business of making money. Their main goal is to earn a profit for their shareholders. Account holders at banks are customers—not members. They have no say in how the bank is run.
How do banks make money?
Retail and commercial banks make money several ways.
Banks charge account holders for basic services like:
- Maintaining an account
- ATM withdrawals
- Wire transfers
- Foreign transaction
- Insufficient funds
Bank fees are a huge money maker, earning these corporations billions of dollars each and every year.
Banks use the money that you deposit in your account to fund their loan offerings like auto loans, mortgages, personal loans, lines of credit, and more.
If you’ve ever taken out a loan, you know that borrowing money isn’t free. Banks charge interest anytime they lend money, creating another significant source of revenue.
Have you ever purchased something from a store that added on an extra fee if you paid with a credit or debit card? That fee is the store passing an interchange fee onto you. Interchange fees are transaction fees that the merchant's bank account must pay whenever a customer uses a credit or debit card to make a purchase.
Advisory Services and Commissions
Some banks offer or have partnerships with companies that provide additional products and services like financial planning, insurance, investments, and more. They may earn a percentage from these services offered.
Banks may make their own investments with the money that they earn, which allows them to earn even more money.
Internet-only banks—sometimes called FinTechs—are relatively new, but they make their money much the same way that brick-and-mortar retail and commercial banks do— fees, interest, and additional services. However, many online-only banks have cheaper fees than their brick-and-mortar counterparts. Because digital banks have less overhead costs, they can pass these savings onto their customers.
Credit unions offer many of the same services as banks. You can keep your money safe in a checking or savings account, take out loans, and take advantage of a wide range of other financial services when you bank with a credit union. Today’s credit unions often have brick-and-mortar locations as well as easy online access.
How do credit unions make money?
Credit unions make money on the interest from loans and from offering additional services to members. They also reinvest money that they earn to generate additional revenue. Some might charge bank fees, but others, like Amplify Credit Union, are proud to be fee-free.
Credit unions are often much, much smaller than banks and serve a much smaller population. Perhaps the biggest difference, however, is what happens after a credit union makes their money.
Credit unions are not-for-profit organizations. This means that the money that they make is returned to the members of the credit union in the form of reduced (or no) fees and lower interest rates on loans. Members are the shareholders, meaning all decisions benefit you, not an investor. Additionally, credit unions give members a voice by allowing them to vote on measures that may affect them.
These organizations also place an emphasis on community reinvestment. You’ll find that most credit unions have ties to local non-profit organizations and are committed to improving the communities that they serve.
Choose a Financial Institution You Can Trust
When choosing a financial institution, ask yourself whether the organization serves you or shareholders. If a bank exists to generate profit from customers, your best interest may not be at the heart of how business is done. At a credit union, you can rest assured that you, the member, is at the center of the institution and its decisions.