How do banks make a profit?

Banks make a profit in several ways, like from interest on loans and deposits, fees, and brokerage services. Here are some details on how banks generate revenue:

• Interest on loans

Banks turn a profit by lending customers money at a higher interest rate in which that bank has borrowed the money from other banks or the central bank. As the customer pays back the loan over time it results in a net profit for the bank.

• Interest on deposits

Banks pay customers interest on the cash that they deposit into their accounts. However, this interest rate is lower than the interest rate the bank charges customers for a loan. This difference between interest rates is known as the net interest margin, and it is a primary source of profit for banks.

• Fees

Banks charge their customers fees for various services, some common ones include account maintenance fees, ATM fees, wire transfer fees, overdraft fees, and late payment fees. The accumulation of these fees can often result in a high amount of profit for a bank.

Banks that can be categorized as investment banks generate profit in many more ways, including brokerage services, underwriting services, mergers and acquisitions, and asset management.

• Brokerage services

Investment banks often act as mediators and liaisons between buyers and sellers in different marketplaces. Normally, for this service an investment bank will charge a commission for specific trades it helps execute. These trades can be for extremely large companies and corporations, or more simple stock trades concerning smaller investors or individuals.

• Underwriting services

Many investment banks also provide underwriting services. These services are for organizations that need to raise funds. This often happens in the scenario of initial public offerings (IPOs).

If an investment bank buys some stock in an IPO with a plan to market the stock to investors, there is a risk of losing money if the investment bank is unable to sell the stock at a higher price. So, investment banks normally use a flat fee underwriting charge to cover any potential losses and also to generate revenue.

• Mergers and Acquisitions

A merger and/or acquisition refers to either the combining of two companies into one business entity or the purchasing of one company by another with the goal of either ingesting the purchased company's business or buying them out for competitive alleviation.

• Asset management

Investment banks also act as asset managers by advising and managing a client's investments. This includes things like stocks, bonds, mutual funds, EFTs, and other investments. The bank's primary objective is to help a client increase their wealth by determining what investments are the best options for a particular client.