How do banks make a profit ?

We have seen earlier what a bank is and what the types of banks are in the previous post. Now, we will look into the topic of banks and their profit.

I’d like you to please read our previous article about the banking sector in India.

Now it’s time to answer a very common question, that is – 👇

How do banks earn profit ?

The answer is simple: banks make profits through ‘interest spread.’ ‘Interest spread’ is the difference between the interest on a deposit and the interest on a loan. As we know, a bank is a financial institution that accepts deposits and gives loans. A bank generates profit through this operation, as interest rates on loans are higher than the interest rates on the deposited money.

Interest rates

The majority of us have an account in a commercial bank where we deposit funds into “savings accounts” in order to accrue interest. The goal of a commercial bank is to make money. In order to receive interest on our deposits, we place our money in a savings account.

The average interest rate on a savings account is 2.5% per year in major banks of our country. And the average interest rate on a personal loan is 10% per year. These are just approximate values of the interest rates. The actual rate of interest is based on a number of factors. The banks make money mainly through this interest spread.

Other sources of profit—non-interest sources

Banks earn a significant amount of money through their non-interest-based operations.

• 1. Account maintenance fees —
  • when we open an account with a bank, the bank charges us certain fees for that account’s maintenance.

• 2. Credit card fees —
  • Credit card is a loan given to us in a card form, so we pay a fees to use such a facility plus we pay the interest rate too.

• 3. Transaction fees for debit card and credit card transactions.

• 4. A fees is charged when we cross a certain number of ATM transactions.
  • When we use an ATM machine other than the issuing bank then we pay some fees to the other bank.

• 5. Minimum balance fees/fine —
  • A few banks have a rule that their customers must have a minimum balance in their accounts. If the balance is less than the required limit then that customer has to pay a certain fine.

• 6. Late payment fees/fine is levied by the banks.
  • When a customer pays the credit card bills after the deadline date.

• 7. Banks invest their money in share market and earn profits through it.

• 8. Banks run their own Mutual funds and invest that pooled money into different assets

• 9. Banks also run their own insurance schemes. Profits are generated through these operations.
  • Banks sometimes act as an insurance agents of a third party insurance company.

• 10. Banks do purchase Govt. Securities from RBI and earn interest rate on G-sec.