When you pay money into your account, the bank doesn’t look after it unless there is something in it for them. Read on to find out more about how banks make their money.
How do banks make their money?
There are three basic ways in which banks make most of their money. They are as follows:
1. Net interest income
This is the most traditional method that banks use to make money.
They take the money deposited and saved by their customers (savers) and use this to provide financial products such as loans and mortgages for other customers (borrowers).
In return for using savers’ money, the savers will be given interest at a specific rate. At the same time, the bank will charge borrowers interest on the amount it lends, and this will also be at a specific rate.
The savings interest rate is lower than the borrowers’ interest rate and the difference, called net interest income, is taken by the bank.
2. Interchange income
Whenever you use your credit or debit card in a restaurant, bar or shop, the person you are buying from (the merchant) pays a fee.
The fee, known as the interchange fee, goes to the card-issuing bank to cover handling costs and the risk involved in approving the payment.
3. Fees and charges
When thinking about how banks make their money, this is probably the most transparent way.
Banks will charge fees for overdrafts, late payments, foreign transactions and exceeding limits due to insufficient funds.
What do they do with the money?
It’s easy to think of banks as ruthless institutions solely interested in making money from their customers.
That’s probably because many of us don’t remember what banking was like before the introduction of ‘free banking’ more than 40 years ago.
Before ‘free banking’ it was common for banks to charge for withdrawals and the majority also charged hefty monthly fees.
Modern banking has had to evolve for many different reasons. So as well as making a profit, banks use their money for investment and maintenance of the following:
- Security systems for the prevention of fraud
- Online and telephone banking systems
- Debit card chip and pin contactless payment systems
- Cheque imaging systems for the faster clearance of cheques
- Free cash withdrawals at their ATMs and other bank ATMs
- Free debit card transactions at specific retailers
- 0% interest-free overdrafts and credit cards for specific periods
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So how secure are my savings?
When looking at how banks make their money, you might think your money is at risk.
But you shouldn’t worry, because your money is protected by the Financial Services Compensation Scheme. This scheme protects UK banking customers from losing a specific amount if a UK bank goes bust.
The scheme covers you for up to £85,000 of savings per financial institution and also covers mortgage balances, insurance and investments.
While some fees and charges are difficult to avoid, banking responsibly can keep them to a minimum.
If you have an overdraft, make sure it stays within your limit. If possible, put together a plan to pay it off in full.
Also, make sure you check your bank statements regularly so you can keep track of your spending.
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