How do banks make money?

For starters, they take the money you loan them and earn a pretty strong return with it, then give you a part of that return in the form of interest. So, each dollar you put into your account with the bank makes them a little bit of money.

Let’s say, for example, that the bank has a savings account with a 1.5% rate of return, which is likely better than the bank in your neighborhood. They take the money from your account (and a lot of other savings accounts) and use all of that money to buy (for example) a treasury note, which is guaranteed by the federal government and returns about 5%.

Even better, let’s say that someone else comes into the bank and wants to borrow some money for a car. The bank offers to lend them the money for the car at 7% return, so they take that money from the accounts at the bank and give it to the borrower. Then, the borrower pays back that money plus the interest, of which they pass on 1.5% to you, keeping 5.5% for themselves.

So, hypothetically, let’s say a bank opens for business and two people open savings accounts at 1.5% with $10,000 each. Then, Judy comes in and wants to borrow $20,000 for a car loan for one year, so the bank uses the $20,000 the people have deposited. At the end of the year, Judy will pay back the $20,000 plus 7% ($1,400). Then, each of the savings account holders come in and clean out their accounts. Each one takes out $10,000 plus 1.5% ($150) for a total of $20,300. The bank thus keeps the remaining $1,100. If that happens, say, 100 times in a year (200 savings accounts, 100 car borrowers), the bank makes $110,000 a year. When you start figuring in long term things like home loans, and also when people buy things like certificates of deposit, it becomes clear that a bank can bring in a lot of money each year.

On top of that, banks today make a lot of money from fees. You get pinged when you use the wrong ATM, when you overdraft a check, and so on. Each of these activities only costs the bank a few cents to handle, but it costs you a few dollars (at least).

To summarize, a bank works by paying people small amounts to lend them money, then lending that money onto others for larger amounts. They manage that whole process, and then keep the difference between the large amount (interest on loans) and small amount (interest from a savings account).