Bank is a financial institution that collects deposits from the public and pays them at a rate of interest. Even co-operative societies are engaged in providing similar services but they are privately owned, whereas banks are recognised and licensed by the government. The funds that are raised by them are lent to the needy people by imposing certain terms and conditions on them.
How does a bank make money?
Banks are broadly categorised into two type namely commercial banks and investment banks. The commercial or retail banks charge the higher rate of interest to the customers and higher fees for managing their accounts. They also charge fees for providing overdraft facility to the customers depending upon the agreed limit. The investment banks earn income by providing advisory services to the newly commenced units of the city, assisting them to issue shares and also by underwriting their shares.
Apart from accumulating public deposits, they also earn revenue from other sources which are stated as below~:
How does a Bank make money using your money?
Extending loans and credits
The primary aim of the banks is to provide investment opportunities to the affluent people and offer the same to the people who require finance. A bank provides loan and credits to the customers or public and imposes the interest rate of interest on the loans provided to them. They provide different types of loans to the customers such as home loans, personal loans, business loans, vehicle loans, etc and levy interest upon the loans depending upon the tenure of the loan and the amount borrowed by them. The rate of interest provided to the customers on deposits is usually higher than the rate of interest charged by the banks for extending the loan to the customers. So, the difference amount is considered as a service charge for processing the loan of the customers. The banks lend two types of loans namely secured and unsecured loan. The rate of interest is higher for an unsecured loan, yet many people prefer to buy unsecured loan because they cannot afford to provide lien as a means of security. They provide both long-term and short-term loans to the customers that are repayable to the customers from 1 year to 25 years.
The customer is also charged with banking and processing fees for opening an account and hence it is a source of income for the banks.
Lending to other banks
When one bank lends money to another bank, interest is levied upon the bank. So, this amount is transferred to the reserve fund of the bank account and this finance is utilised during the times of emergency and for proper maintenance of accounts. They provide short term credit to the other banks at a higher rate of interest and this interest is also used for financing day-to-day transactions of the bank. The rate of interest charged on banks is even higher than the rate charged for loans to customers. Similarly, they can lend their surplus asset to another bank on lease or loan and earn the rate of interest every month to finance their daily needs. Even if the bank owns enough liquid assets, then they can lend it to the other banks. So, the banks can lend or borrow money at a certain rate of interest depending upon the market conditions of the bank and earn profits.
Where do banks get their money?
When the customers open an account in a bank, they should pay service fees, processing fees, fees for acquiring documents and pass book, ATM and loan fees. They collect fees for processing accounts of the customers and preserving their money because they should pay wages and salaries to several employees of the bank.
Auction of assets
The secured debtors sometimes are not able to repay the loan due to their financial conditions. So, the bank recovers the amount of the defaulters by mortgaging their property that was offered to them in the form of collateral security. So, in this way they can auction many types of assets such as house, car, jewellery, vehicles, etc. So, the auctioned property can be easily sold at a profitable rate and also the bank incurs low expenses for disposing of these assets.
How does a bank make most of its profit on its business?
Offering credit cards
Most of the customers are eager to buy credit cards of the banks, although their rates of interests are higher because they can immediately buy the product that strongly urges them. Apart from earning the higher rate of interest, they also earn income by imposing processing and other fees.
Trading in securities
Most of the banks invest in securities such as forex, commodity, equity etc and their customers are also the investors in such financial instruments. So the customers can gain the higher rate of interest and hence the banks can attract more customers by offering the higher rate of interest to the customers and also advice the new customers to invest in securities. They also earn money by trading these securities in the secondary market. They can sell the securities at a higher rate than purchased by them. Some banks also buy and sell currencies of other nations and extend credit to the customers depending upon the fluctuations in the forex market conditions.
Financial advisory services
The newly commenced units or private limited firms require the advice of the investment banks concerning the rate of the issue price, a number of shares to be issued, price per share at application, allocation and call stage. So, the bank charges advisory fees to the companies and also assists them ineffective execution, prospectus and finalising the deal for the company. Sometimes, when a company is merging with the other company or is acquiring the assets of other company, it requires advice and assistance for negotiation with the merging companies of the reputed banks.
To avoid the risk of theft and burglary at home by retaining expensive jewellery or lump sum cash at home, most of the customers want to maintain them in a safety locker. So, they place their jewellery and cash into the safety lockers of the banks. So, the banks charge monthly rental charges for preserving the assets and also annual charges for maintaining it. The banks need not hire additional manpower to guard the vaults of the banks and hence does not incur additional expenses.