Where do banks make money – deposits, loans or both and how is that measured?
The number and types of services and products offered by banks is constantly evolving. Gone are the simple days of banks only earning revenue based on the loans that they made from their total gross deposits.
The fundamental changes in the banking industry are so significant that it isn’t an exaggeration to state that as a lender, your very survival and profitability depend on the answer to one question:Where do banks make money – deposits, loans or both and how is that measured?
In the early days of banking, institutions made loans from their deposits. Currently, deposits remain important due to the FDIC’s minimum reserve-deposit ratio requirements which require well capitalized banks to keep 10 percent of their combined Tier One and Tier Two Capital on hand for liquidity purposes and to help to ensure a bank’s long term financial stability.
Why Deposits are Important
These Federal requirements make it important for banks to be able to correctly determine the number and amount of deposits that they have on hand at any given time. Since having an adequate amount of deposits on hand is important to meet these government requirements, banks often pay depositors a certain percentage rate of interest for keeping funds in savings accounts as well as banking products such as Certificates of Deposits (CDs).
The Value of Fees
It is also for this reason that fees are often assessed to customers who have overdrawn their account. Additional fees are often charged to handle other customer transactions, such as mailing statements, providing copies of other types of financial documents, or even transaction fees related to bank card processing and merchant fees.
Over the years, these types of fees have become a significant but fluctuating source of revenue for some banks and lending institutions. A prime example of this phenomena is the recent announcement of a quarterly increase in earnings by United Bankshares, Inc.
This particular bank reported a $4.5 million USD increase in revenue for the first quarter of 2015 as compared to the figures for the first quarter of 2014. This is despite the fact that non-interest income from the bank decreased $1.2 million USD from the last quarter in 2014. This decrease was due to a decline in the number of overdraft charges incurred by depositors and a decline in the volume of bank card transactions which resulted in the collection of less bank merchant fees for the period.
As one can clearly see, if the revenue from fees had remained consistent, the bank’s increase in revenue for the first quarter this year would have been 25% higher. The data reported by United Bankshares is a story that repeats at banks and lending institutions across the nation. Fees for deposit related services can be significant but are incredibly unstable and undependable.
One can only conclude that aside from the requirements for banks to acquire and maintain a certain level of deposits, banks truly make most of their money by earning a sufficient level of profit on the loans that they grant, with commercial lending providing the potential for significant more revenue than personal loans.
Why Loans are the True Profit Centers for Banks
Earning a profit on a loan is not just a matter of simply charging a given amount of interest on the amount that is loaned. The profits that banks earn is an increasingly small margin. This is due not only to fluctuations in fees, and the number and types of products and services offered, but also due to changes in the regulatory landscape which continues to place greater demands for profitability on banks.
Why Banks Need Reliable Loan Pricing Models
It is for these reasons that there is now an even greater need than in the past for bankers to have a reliable loan pricing model that produces consistent results.
Our PULPS Loan Pricing Model can provide you with the reliable and consistent model that you need. contact us today to learn more about how we can help you to take the guess work out of pricing your loans and help you ensure a long and prosperous future for your organization.