What if you are surprised by your little ones at home with the question ‘how do banks make money?’ What would be your answer?
One fact is certain, banks are after all businesses and as businesses go, they have expenses to cover and need funds for their effective functioning. This rules out the idea of banks not making money away.
The first thing you need to know is that the bank is like a shop that buys and sells money in various forms like loans, deposits, certificates of deposit and many other types of financial products.
The bank’s fundamental business is borrowing and lending money and they earn from the interest that they derive from independent customers. The interest at which they lend money is always higher than what they borrow money at.
This difference in interest rate is the main profit earned by commercial banks. The money they lend out are essentially from other customers who deposit theirs in banks as longterm saves. This means that the rate of interest that a bank charges is entirely dependent on the demand and supply for a particular amount, the number of people who are ready to borrow the amount and the exact amount that the bank can spare as loan.
Banks also charge customers a certain amount as charges or fees for taking care of the bank accounts of individual customers. Other charges levied by the bank like charges levied for overdraft facilities or cheque facilities and the likes also add to their income.
Upcoming companies often seek the advice from established financial institutions like investment banks for effective execution of their plans. The bank provides crucial advice in terms of what rate the issue should be priced, the total number of shares issued, conducts the due diligence of the interested company and many such associated services. And of course, all of this is for a price, this is the advisory fee that the bank charges in return for its services and the time it spends to finalize the deal for the specific company.
Banks, especially the investment banks are active traders in the equity, forex and commodity markets. Banks with people's funds invest in various securities trading as well as open positions in the debt market as well.
It is easy to see that some individuals are scared to keep their precious jewellery, important documents at home. They are nervous of theft, and the bank comes to the aid of all such customers.
They have vaults of various sizes and dimension to suit the needs of many different types of customers who require these vault services. The bank charges annual fees for the maintenance, upkeep and also monthly rental in return for these services. While customers are happy that their precious documents and jewelry are in safe hands, the banks use this opportunity to maximise it's profit base.
Also, when an individual or a company defaults on a specific loan, the bank impounds on the collateral that was given in exchange of the loan amount and puts it up for sale. These are wide range of products ranging from houses, cars and other personal belongings including jewellery.
Auctioning these properties is an easy way for the bank to recover the defaulted loan amount as well as let go of the collateral that it had taken over.
There are many other services that a bank caters to and levies charges on like teller services, checking statements and account balance, accessing the bank account from any ATM which might not belong to the parent bank and the like.
In conclusion, as all businesses are, banks rakes in significant sum by meer numbers of customers. Banks certainly makes sure their business of trading money becomes a means of making money!