· Listen
Banks make money in three main ways: net interest margin, fees, and trading. Understanding the first one explains a lot about your everyday experience as a customer.
Net interest margin
The bank takes deposits from you (paying you, say, 0.1%), then lends that money out as mortgages, business loans, and credit cards (charging, say, 7%). The 6.9% spread is their core profit. The bigger that spread, the more profitable the bank.
This is why traditional brick-and-mortar banks pay so little interest on savings. Every dollar they pay you cuts into their margin. They keep paying you almost nothing because most customers don't shop around.
Fees
Overdraft fees, ATM fees, account maintenance fees, wire transfer fees, foreign transaction fees. Fees are a major bank revenue source. Avoiding them is one of the easiest financial wins available.
Trading and investment banking
Bigger banks also make money through trading, advisory work, underwriting, and asset management. This is where Goldman Sachs and JP Morgan make most of their profits, while regional banks rely mostly on net interest margin.
Online banks pay much higher rates because they have lower overhead: no branches, fewer staff. They pass some of that savings to you. There's no catch; just a different cost structure.
What this lesson is NOT
This explains how banks earn money and why that keeps everyday savings rates low. It is not a claim that banks are cheating you, and it is not a guide to which bank to choose.
Quick check on this lesson
Answer each question and we’ll show you why the right answer is right, and why the others aren’t.
- 1.
Per the lesson, what are the three main ways banks make money?
- 2.
In the lesson's example, a bank takes deposits at 0.1% and lends that money out at 7%. What's that ~6.9% gap called, and what does it represent?
- 3.
Per the lesson, why do traditional brick-and-mortar banks pay so little interest on savings?
- 4.
Per the lesson, which of the following are bank fees that the lesson lists as a major revenue source?
- 5.
Per the tip callout, how can online banks afford to pay much higher interest rates than traditional banks?
0 of 5 answered