It’s well-known that banks are among the largest corporations that bring in massive amounts of revenue for their financial services. So, how do banks make money?
Banks bring in income from interest charges and fees as well as through investing in real estate, commercial or consumer loans, and government securities. Banks might also invest in public companies.
Types of banks and how they invest and make money
There are several major categories of banking institutions.
First, commercial banks tend to make most of their income through interest fees. Commercial banks are often where everyday customers open checking and savings accounts. At a commercial bank, you might secure a mortgage or open up a CD (certificate of deposit).
Commercial banks borrow money at low interest rates, then make money by charging higher interest rates to their borrowing customers.
Investment banks serve institutional clients and high-net-worth individuals. They help companies with the IPO process, advise businesses during mergers and acquisitions, and often offer wealth management services. Their revenue mainly comes from fees. These banks usually have their own investment portfolios as well.
Where banks invest their money
Banks can invest a portion of their funds in various investment vehicles including real estate, government securities, and commercial and consumer loans.
Real estate investments for banks include the mortgage lending arm of the business. Banks offer long-term lending on homes, farmland, and business property. They also invest in home equity lines of credit and construction loans. Loans might be fixed-rate or variable rate, both of which offer different benefits to the lender and the borrower.
Banks also invest by providing business loans. Small businesses and others borrow funds in fixed amounts or via a line of credit through the bank, from which the bank takes interest charges.
Consumer loans account for a portion of banks’ investment income as well. Individuals borrowing money for an automobile purchase, furniture purchase, or other large expenses can reap interest rewards for the lending bank.
Government securities like Treasury bills and bonds are also part of many banks’ investment portfolios. The New York Times reported last month that banks are being forced to invest more of their cash in government bonds and securities because fewer customers are taking out loans.
Banks like Bank of America and Wells Fargo stated that they're bringing in less income from lending because customers don’t need as many loans. Thanks in part to economic stimulus payments and enhanced unemployment benefits, many Americans have paid off credit card debt and avoided taking out bank loans.
Although the higher bank balances are clearly a source of financial security for consumers, banks still need to make money somehow. Deposits at commercial banks were 30 percent higher than pre-pandemic deposit levels as of late August, according to The New York Times. This drives many banks to invest more in government bonds to earn the interest they need for operations.