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How Do Banks Make Money?

29 December 2021

Banks run on a profit-based business model. Similar to any other business, they have their sources of income and expenses. Their operations primarily involve borrowing and lending money. 

Here is a detailed guide to answer all queries about how do banks make money in India. 

How do Banks Earn Profit?

There are various avenues through which banks earn money. These include the following:

Net interest margin

While banks borrow funds at a lower interest rate, they tend to charge comparatively higher interest rates on loans that they disburse. The difference in these interest rates is called net interest margin, which acts as a significant source of income for banks.

The money that customers deposit in their savings and/or current accounts is the money that banks borrow. Moreover, banks borrow by offering fixed deposits or recurring deposits. 

On the other hand, banks earn by charging interest on financial products such as home loans, personal loans, car loans and others. 

The difference between these two interest rates is what banks focus on maximising. 

Interchange fees

Interchange fees are another major source of income for banks. It is the charge that financial institutions levy for carrying out transactions with debit cards or credit cards.

Whenever a customer makes a purchase and swipes their cards, a specific charge is levied on the merchant. The majority of the interchange fees go towards the customer’s bank. The rest goes towards the merchant’s bank.

Account and ATM-related fees

In addition to interchange fees, a bank levies a wide range of charges such as the following:

  • ATM fees

Customers are allowed to carry out a certain number of ATM transactions per month from ATMs belonging to banks other than the issuing financial institution. Customers have to pay a certain fee if they make ATM transactions beyond that limit.

Moreover, some banks charge another type of fee for performing transactions at home ATMs beyond the set limit.

  • Minimum balance fees

Certain banks require their customers to maintain a minimum balance in their accounts. If the balance drops below this limit, one has to pay a specific fine. 

  • Late payment fees

Customers who miss the deadline for payment of credit card bills have to pay a late fine. This fine will, however, vary from one bank to another.

  • Investment fees

 Banks that offer investment services might also levy investment fees. They will levy such fees for handling client investments and other related services. 

Other Sources

  • Interest on investment

Sometimes financial institutions invest in different government and rated securities. They earn significant interest through these investments. 

  • Forex operations

Financial institutions are also involved in foreign exchange operations where they act as brokers. These operations also bring income to banks.

  • Commission earned on third party products

Banks also earn specific commissions through distributing mutual funds or insurance products to their consumers.

Typically banks earn their profits by acting as a bridge between borrowers and depositors. At the same time, they incur various expenses for carrying out operations. In case borrowers default on loan repayments, banks have to cover the losses by utilising their earnings. 

 

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