??Banking Business

Businesses as a force of nature is to either sell a product (commodity) or a service. Money, in its essence, is a commodity used to procure other commodities or services. There is one business in the world that is strikingly different, relatively much more powerful and high paying, Banking.

Banks are a stronghold and the backbone of a succeeding economy. The American Banks at large (with the Chinese, of course) boast a global foothold making them heavy influencers in all sectors of the economy. 

As we take our loans, deposit our money, take credit cards and insurances, How do Banks make Money? 

Net Interest Margin:

Banks give out several types of loans (auto, home, student etc) and charge an interest rate known as the Annual Percentage Rate (APR). The interest revenue is what the bank earns. Simple.

On the other hand, the rate the bank pays you money to deposit your money - the Checking Rate. This is what it costs the bank to get the money to give as loans in the first place. 

With most people paying more than they earn simply due to loan interest rates being higher or people having more revenue streams (i.e. several loans), there exists a net interest margin (Interest % for Loans > Interest % for Deposits). This ensures the bank's revenue is more than its spending, resulting in a profit. This is the oldest and most basic way banks make their money (usually the largest share for earnings). 

Credit Cards:

Every time you pay using a credit card, it's a sort of loan you take to spend on things, albeit with seemingly no cost or interest. However, when delayed (which is more often than you think) a huge chunk of the payments are able to earn interest, with the average being almost 15%.

When banks play this on volume with hundreds of thousands of users, individual interest payments on the card lead to massive profits. 

Fees:

Fees are by far the snarkiest way Banks make money. Every time you use your card to buy something, an interchange fee has to be paid by the seller to their bank, and your bank. The interchange fee is “justified” to facilitate the funds transfer and is about 2% (3% for AmEx - that’s why you don’t see it around much). Despite being so small (which they really aren’t), growing transactions using Cards simply means its more revenue for banks, as after a certain point it doesn’t cost as much for an added transaction after the fund-transfer infrastructure is in place.

Fun Fact: If you ever wondered how credit cards afford airline miles and other rewards, the interchange fee revenue plays a huge role in offsetting those expenses. 

Other types of fees - Late fees, ATM Fees, Deposit Fees, Service Fees, Maintenance Fees and much more (the list doesn’t end) add up. 

One significant fee is the commission they earn when they broker trade on financial markets. The banks make a cut on every transaction, regardless if you made a profit/loss, in some way guaranteeing their profit.

Portfolio Management:

What we discussed so far were the “direct” methods banks make money. Like any of us, banks invest their money to maximize their returns on money they have sitting.

When the bank houses money (from your deposits), they put it to work. The “bankers” step in, having floors of traders and analysts, Banks use the cash at hand to invest in several avenues and markets. This way, the banks also grow horizontally by offering wealth management services, Mutual Funds, SIPs and much more for something -  you guessed it, fees. As the bank grows, its management of funds grows, exposing more avenues of investments. 

It's almost a cycle. They first take your money, earn it by loans etc., then when they want to invest that earned money (which is your money in the first place) they again charge you some commission/fee, which earns them more on it, and so on.

From Reserve Banks:

The oversight body for banks in a nation is the Reserve Bank. There are instances where the federal reserve needs funds - could be for quantitatively easing the economy and stimulating it (now would be a good time). In certain cases, the reserve banks borrow money from commercial banks at an interest rate called the REVERSE REPO RATE. The interest earnings from this is a safe bet for banks, as the Reserve bank is eventually going to pay, no matter what. While this may be slightly lower than the interest they get from loaning out to individuals and businesses, it's often preferred as the Reserve Bank usually borrows large sums, hundreds of thousands of times more than an individual would, and also has the bonus of being a guarantee, while borrowers may default (2008 Horrors). 

While banking is what makes the world go round today, it is crucial to understand how they are able to afford and sustain providing these near-essential services, from the extent, scope and depth of several revenue streams.