How Do Banks Make Money? the Fallacies of Fee Income

TLDR

The article notes that the common perception of bank profits as merely interest margins is misleading, citing the tongue‑in‑cheek 3‑6‑3 rule that oversimplifies the reality of banking income. Banks generate fee income through a range of traditional services, including transaction and cash‑management, safe‑keeping, investment accounts, and insurance products. While interest margins remain the main profit driver, banks increasingly earn significant noninterest income from fees, especially as new financial processes boost fee earnings in consumer lending and retail payments.

Abstract

Introduction and summary “How do banks make money?” is a deceivingly simple question. Banks make money by charging interest on loans, of course. In fact, there used to be a standard, tongue-in-cheek answer to this question: According to the “3-6-3 rule,” bankers paid a 3 percent rate of interest on deposits, charged a 6 percent rate of interest on loans, and then headed to the golf course at 3 o’clock. Like most good jokes, the 3-6-3 rule mixes a grain of truth with a highly simplified view of reality. To be sure, the interest margin banks earn by intermediating between depositors and borrowers continues to be the primary source of profits for most banking companies. But banks also earn substantial amounts of noninterest income by charging their customers fees in exchange for a variety of financial services. Many of these financial services are traditional banking services: transaction services like checking and cash management; safe-keeping services like insured deposit accounts and safety deposit boxes; investment services like trust accounts and long-run certificates of deposit (CDs); and insurance services like annuity contracts. In other traditional areas of banking—such as consumer lending and retail payments—the widespread application of new financial processes and pricing methods is generating increased amounts of fee income for many banks. And in recent years,