Banks often get a lot of crap for poor judgment, a lack of customer service, and 
thoughtless business moves but we often forget that a majority of people use banks for free.
There is no fee for a majority of the checking and savings accounts out there. These banks host our money, insure it up to $250,000, and provide their employees and services with no charge.
So how do big banks make money?
Well, they offer other money-making services like auto loans and mortgages. They also take your savings and invest it elsewhere (more on this later). And credit cards are also a way for banks to make money off you – when you don’t pay off your balance on your bank’s credit card, the extra interest you pay goes in to the banks pocket.
The big banks have a lot of different income streams and although some recent government legislation is threatening some of the less moral money-making practices, big banks are doing all right.
But what about the smaller online banks that don’t have 49 different income streams? How do they make money?
I started thinking about this when an FF reader asked last week on the Ally Bank Review post:
It’s great that they’ll be giving me more interest for my money then my current brick & mortar bank – but what is in it for them? Is there a service charge or any hidden fees somewhere?
I quickly realized that I had no idea how Ally – a very bare bones bank – made money. They don’t offer any sort of loans or credit cards so there is no obvious income streams located on their homepage.
In fact, they only offer 4 products – checking, savings, CDs, and money market accounts. All of these accounts cost $0 to open and have no monthly fees.
I decided to go straight to the source and see if Ally’s customer service would honestly answer the question: “How does Ally make money?”
Surprisingly, they offered an honest answer with no prying:
Our accounts are invested in long-term mortgages and real estate. Ally Bank does not engage in targeted sub prime lending activities, and information on the Bank’s level of loan loss reserves and classified loans is available on www.fdic.gov.
The specifics of the investments are left out, but I respect Ally’s honesty.
Just like big banks, they take your dormant money located in savings, checking, and CD accounts and invest it elsewhere. They can easily afford to pay their customers 1.5% in interest when they’re getting returns above 7% by investing your money in mortgages.
Almost all of us have large sums of money in banks so it’s good to ask these questions and understand what we’re really getting involved with when we sign up for a bank account.
Further reading: here’s a link to the fracational-reserve banking Wikipedia. This goes more in depth about the process of banks holding cash vs. lending it out.
Do you know how your big, online, or local bank makes money?
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Austin you may want to look up fractional reserve system, I think it would make the whole thing a lot clearer
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Thanks for the heads up, Evan. It’s definitely something I need to learn a lot more about.
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Great post, Austin.
One more thing is that Ally Bank can offer better savings, money market, CD and interest checking interest rates since they don’t have the overhead costs of maintaining and staffing brick and mortar branches. A portion of those savings get passed along to customers in the form of better rates.
That savings also works on the ATM side of things. Since Ally doesn’t have any ATM machines to place, maintain and share fees with location owners (grocery stores, malls, etc.), they’re able to allow Ally customers to use any ATM for free and will reimburse any fees that are charged. That’s also a big win for customers
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i want to loan for small bussness in chennai pls help us i will doing sign fabrecationwork in chennai ihave the saving account in bank of india
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