To answer the question, “Where do banks get money to lend to borrowers?”, there are a few things to note. While the banking industry might be pretty complicated, how banks make money can be pretty straightforward.
First, banks get money by borrowing money from depositors and compensating them through interest rates. The banks will lend out loans, charging borrowers a higher interest rate and profiting from the interest rate. Banks also get money by offering financial services such as investments and wealth management. Plus, most banks also charge non-interest fees.
Most people consider banks a safe place to store their money for future use. However, Banks serve a much larger purpose.
They act as the primary money supplier to a country’s economy by lending to borrowers. But people are still unaware of where banks get money to lend to borrowers. We’ve compiled this simple guide to fully understand where banks get the money to lend to borrowers.
Where Do Banks Get Money to Lend to Borrowers?
While banks make a lot of money, most of us do not know where banks get the money.
Most Americans think the bank gets money from deals on Wall Street. However, you may not know that banks get money to lend to borrowers from different services they offer to individuals and corporations.
The way the bank gets money is primarily determined by the type of bank and services they offer. This section will break down where banks get money to lend to borrowers. We’ll also give you a brief description of the different sources of income.
1. Loans
Most banks get money from loans, charging interest on loans. Banks offer loans to businesses and individuals. There are different types of loans, including car, home, and personal loans.
For example, when an individual takes out a mortgage to buy a house, this is a home loan. However, banks don’t give out banknotes. Instead, it credits their bank account with a bank deposit of the value of the mortgage.
This way, the bank can get money to lend to borrowers. By creating money through this method, the bank can also add more money to the economy.
Of course, the downside of getting money through loans is that every new loan comes with debt. If debt levels become too high, a wave of bankruptcies may occur, potentially triggering a financial crisis.
2. Depositors
This is the primary way that banks get money to lend to borrowers. They do so by getting money from depositors who do not need their money immediately. In return, they award depositors with an interest rate and safekeeping of their money.
The bank will then use this money to lend to borrowers who need the money now rather than later. The lenders will be required to repay the money at a higher interest rate than what they initially paid to depositors.
3. Capital Markets-Related Income
One of the banks’ major services to corporations and inventors is capital market services. Firstly, what is a capital market? Capital markets in the context of banks act like a marketplace that matches businesses that need capital with investors.
Banks also serve as a middleman, offering several services under capital markets, such as sales and trading. They will run trades with their in-house brokers. Furthermore, banks will form dedicated investment teams for different sectors to assist with loans and equity underwriting.
These services essentially contribute to a massive percentage of where banks get money to lend to borrowers. In fact, most banks rely heavily on capital markets services at a particular period. However, money earned varies depending on various conditions, such as economic crisis and growth.
4. Banking Fees
Banks also get money to lend to borrowers by charging other fees apart from interest rates. These charges are determined mainly by the account or service you select. Banking fees are an excellent way for banks to get a reliable source of income because it does not fluctuate.
They are beneficial during recessions, where low-interest rates and capital markets services slow down. While most banks can make money from interest rates, they earn a larger share from non-interest rates.
Bank Account Fees
If a client opens a bank account, the bank may charge a monthly account fee to keep it activated. Bank account fees also include bank-related fees such as fees for overdrafts and insufficient funds.
Some banks, however, offer a zero account opening fee if you’re eligible. Check with your bank to learn about their rates and whether they charge fees.
Credit Card Fees
Credit card fees are another source of income for banks. Cardholders pay an annual or monthly charge when using a bank-issued credit card. They charge these fees on cash advances, balance transfers, and late credit card payments. In addition, banks also get money from APR (annual penalty percentage).
Investment and Wealth Management Fees
Since banks provide investment services to corporations and individuals, they can also charge investment management fees. Some banks get money from wealth management fees. They’re also able to profit from mutual funds.
ATM Fees
Let’s not forget ATM fees. Cardholders can carry out various ATM transactions from ATM cards belonging to different banks. However, they will need to pay specific fees. While customers view these fees they incur from ATM transactions as a loss, this counts as another source of income for banks.
Other Fees Banks Make Money From
A lot of banks also get money from bank commissions. Banks can charge more than what brokerage firms charge. Which can earn them a lot of money. There are also accounting fees made from accounting services. On your monthly report, they will appear as maintenance fees.
Some banks are also involved in forex exchange services where they act as brokers. These services also bring in money.
Key Takeaways
Essentially, they need to make money for banks to lend to borrowers. Banks are pretty resourceful in getting money. This can be seen by the amount of money they can lend to borrowers.
The general notion about where the banks get the money to lend to borrowers depends on the cash inflow from various banking services.
Based on what we previously mentioned, the bank gets the money mainly from deposits and fee-based services. The reserve system in the bank also contributes a fraction of the deposits held in the bank as cash or electronic payouts.
Banks also get the money from interest rates. While the interest rate method is quite simple, banks are smart enough to issue interest rates that can give them a substantial sum of money.
It is essential to note the amount of money the bank can lend to borrowers depends on the amount it receives in various ways. Now you hopefully have a better understanding of the banking system.