by Hillary Patin

How Do Banks Make Money?

When you were first choosing a bank, did you stop to think about how banks make money?
How Banks Make Money

Have you ever wondered why your checking account is free, or why your bank gives you small amounts of interest every once in a while? It almost feels like you’re the one making money. So, it begs the question, how do banks make money?

There are three main ways banks make money:

  • Net interest margin
  • Interchange
  • Fees

Here’s a brief introduction into each of these ways and what to look out for when choosing your bank.

Net interest margin

When you deposit money into your bank account, you’re giving your bank permission to use your money to make loans. Your bank loans your money out to others at a cost to the lendee, in the form of an interest rate (think: mortgages, student loans, car loans, credit cards, etc.).

Banks collect money off the interest paid by borrowers, and a small amount of that interest is given back to customers. This is partially due to customers’ expectation that they will see a return when they deposit their savings with a bank, as well as the bank’s way of saying thank you for banking for us. The difference between the amount of interest banks earn by leveraging customer deposits through lending products (auto loans, mortgages, etc) and the interest banks pay their customers based on their average checking account balance is the net interest margin.

Even though your money is being loaned out to other people, you can withdraw all of your money out of our bank account right now without a problem. This is because banks are required to keep a minimum fraction of customer deposits on hand at the bank, known as the reserve requirement. In the U.S., the reserve requirement is set by the Federal Reserve, or The Fed.

Interchange

Interchange is the money banks make from processing credit and debit transactions. Each time you swipe your card at a store, the store, or merchant, pays an interchange fee. The majority of money from interchange goes to your bank–the consumer’s bank–and a little goes to the merchant’s bank. Interchange is also how many banks are able to offer such high credit card rewards. Merchants are assessed at a higher interchange fee when reward program credit cards are used to make purchases. Some banks cover the cost by charging membership fees to credit or debit card holders.

Because merchants have no control over interchange fees, there has been a lot of discussion as to how much banks should be allowed to charge for this fee.

Following the global financial crisis in 2008-2009, legislation was passed that capped interchange fees on debit cards in order to provide some relief to merchants. In light of the downturn in the economy due to the COVID-19 pandemic, many merchants are now arguing for legislation that would also impose a similar cap on credit cards.

Fees

Fees are a relatively modern banking phenomena. In 1978, the Supreme Court ruled that banks could charge interest according to the laws of the bank’s home state of operation. Then in 1996, the Supreme Court built upon this ruling in the landmark case, Smiley v. Citibank, finding that credit card late fees and other penalties should be included under the definition of “interest.” Following this ruling, states began to pass laws lifting limits on banking fees in an effort to draw banks’ business to their states. As banks moved to states where there were little to no limits on banking fees, there was a significant spike in late fees.

In 2007, two Acts were proposed to change the way that banks charge fees, but neither made it past Congress. However, in 2010, a federal law was passed that requires that consumers must agree to debit card overdraft coverage with their banks before fees are charged or services are provided.

This hasn’t slowed the impact overdraft fees have had on consumers. According to BankRate’s 2019 Checking Account and ATM fee study, the average overdraft fee is $33.36. In fact, the average non-sufficient funds fee increased for the 19th time in the past 21 years.

While late fees, overdraft fees, and ATM fees are relatively well known, there’s also a host of other fees that banks may charge customers. So when choosing a bank, it’s always important to read the fine print to make sure you’re aware of when you might be charged.

How Simple makes money

At Simple, we make our money through net interest margin, personal loans, and interchange:

  • Like traditional banks, Simple and our partner bank split the interest margin - the difference between the amount of interest made on loans, and the amount of interest paid to customers for balances.
  • When you swipe your debit card, the merchant pays a service fee (interchange) to the issuing bank. Our partners split this with us.

Simple or our providers may charge you in the following cases:

  1. When you order a new checkbook—a book of 25 checks costs $5, just to cover the costs of materials and shipping.
  2. If you use an ATM outside of our fee-free network, the ATM owner may charge a fee.
  3. If you use your card internationally, Visa will charge an International Service Assessment (ISA) fee of up to 1% of the total transaction amount.

Learn more about how Simple makes money, and answers to other Frequently Asked Questions on our FAQs page!

Interested in getting started with Simple? Apply now!
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Disclaimer: Hey! Welcome to our disclaimer. Here’s what you need to know to safely consume this blog post: We do our best to make sure information is accurate as of the date of publication, but things do change quickly sometimes. Any outbound links in this post will take you away from Simple.com, to external sites in the wilds of the internet; neither Simple nor our partner bank, BBVA USA, endorse any linked-to websites; and we didn’t pay/barter with/bribe anyone to appear in this post. Individual situations will differ; consult your favorite finance, tax or legal professional for specific advice. And as much as we wish we could control the cost of things, any prices in this article are just estimates. Actual prices are up to retailers, manufacturers, and other people who’ve been granted magical powers over digits and dollar signs.

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