How Traditional Banks make money from you? Copy

Binal Gandhi
Board of Directors
October 9, 2020

Bank branches may seem like an antiquated way to conduct banking in this day and age (we certainly think so), but traditional banks’ business models are built around them. We’ve written before about how these branches provide an extremely poor customer experience and, infuriatingly, cost you $200 (or more!) per year even though you have no interest in visiting them.

Still, banks have to generate revenue in excess of what it costs them to operate branches whether you like it or not – and in order to do that, they get creative about finding ways to make more money off of you. Here we’ll explain three major ways traditional banks do that and what it means for you as a consumer.

They don’t pay you interest on your deposits

The biggest way banks make money is by minimizing the interest they pay you on your deposits. In banking jargon, this is known as maximizing their “net interest margin” – but it’s just a fancy way of saying they’re making money on your money and not passing it along to you.  When you deposit money at your bank, it doesn’t just sit there. Your bank loans it out and earns interest on those loans. Ideally, your bank would then share that interest with you. In reality, they seldom do. Banks have a strong incentive to pay you as little as possible because banks with the lowest cost of funds (read: those that pay the least interest) tend to have the highest relative valuations (meaning they’re seen as more profitable). In short, they maximize the interest they earn while minimizing what they pay you on your own deposits.

Its not about having lots of money. It’s knowing how to manage it.

Let’s look at what this means for you. Say you have a checking account that earns no interest (which is fairly common). You deposit $10,000 into that account and your bank then loans out your cash. If your bank earns 2.8% loaning your money out for mortgages but pays you 0% APY, they’re earning a 2.8% net interest margin on your cash that’s equivalent to $280 over the course of a year – and you’re earning nothing. They could raise your APY, but then they’d make less money.

They charge you unnecessary fees

Speaking of minimum balances, most banks will charge you a fee if you fall below a particular account balance. Worse still, you can trigger this fee if you fall below the threshold even once – even if your average account balance far exceeds the minimum and even when you hold a balance way above the threshold in another account at the same bank. This is just one example of the many account fees banks charge to make money off of their customers.

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