Banks get money from three main sources: deposits from customers, borrowing from other banks and the Federal Reserve, and revenue from fees and lending

When you put money in a checking or savings account, that becomes a bank's money to lend out. The bank pays you interest on your deposit—usually a small percentage—and then lends that same money to other customers at a higher interest rate. The difference between what they pay you and what they charge borrowers is how banks make their primary profit. This is the core of retail banking, and it's why banks actively want your deposits.

Beyond customer deposits, banks borrow money from each other through overnight lending markets, and they can borrow directly from the Federal Reserve at a rate called the discount rate. During financial crises or when a bank needs short-term cash to cover withdrawals or meet regulatory requirements, these borrowing channels keep the system functioning. Banks also raise money by issuing bonds and selling stock to investors, which gives them capital to lend out or hold as a safety buffer.

Key Takeaways

  • Customer deposits are a bank's primary funding source, and banks pay depositors interest while charging borrowers more to create profit.
  • Banks borrow from each other and from the Federal Reserve to cover short-term cash needs and meet regulatory capital requirements.
  • Banks generate revenue through loan interest, overdraft fees, ATM fees, account maintenance fees, and investment services.
  • The Federal Reserve sets the baseline interest rate that influences how much banks pay depositors and charge borrowers.
  • Banks must hold a percentage of deposits in reserve and cannot lend out every dollar customers deposit.

How deposits become loans

When you deposit $5,000 into a savings account, the bank doesn't lock that money in a vault with your name on it. Instead, the bank adds $5,000 to its pool of available funds. It then lends portions of that pool to mortgage borrowers, car buyers, small business owners, and credit card users. The bank keeps a fraction of deposits in reserve—the amount varies by account type and is set by the Federal Reserve—and lends out the rest.

This system is called fractional reserve banking. If a bank has $100 million in deposits and must hold 10 percent in reserve, it can lend out roughly $90 million. That $90 million goes to borrowers as new loans. Those borrowers then spend the money, and it often ends up deposited in other banks, which lend it out again. This cycle multiplies the money supply in the economy without the Federal Reserve printing new currency.

The interest rate the bank charges borrowers minus the interest rate it pays depositors equals the bank's net interest margin. If a bank pays you 0.5 percent on savings but charges a borrower 6 percent on a car loan, the margin is 5.5 percent. That spread funds the bank's operations, salaries, technology, and profit.

Borrowing from other banks and the Federal Reserve

Banks don't always have enough deposits on hand to meet customer withdrawals or to lend as much as they want. When that happens, they borrow from other banks through the federal funds market. This is an overnight lending system where banks with excess reserves lend to banks with shortfalls. The rate they charge each other is called the federal funds rate, and it's set by the Federal Reserve.

If a bank faces a more serious cash shortage, it can borrow directly from the Federal Reserve's discount window. The Fed acts as a lender of last resort, charging a rate slightly higher than the federal funds rate. During the 2008 financial crisis and the 2020 pandemic, the Fed lent billions to banks to prevent collapse. Banks repay these loans within days or weeks, not months.

The Federal Reserve also influences how much banks can lend by raising or lowering the federal funds rate. When the Fed raises rates, banks pay more to borrow from each other, so they raise the rates they charge customers and lower the rates they pay depositors. When the Fed lowers rates, the opposite happens. This is why your savings account interest rate changes even though you didn't change anything.

Fees and investment income

Interest on loans is not a bank's only revenue stream. Banks charge overdraft fees when an account goes negative, ATM fees when you use another bank's machine, monthly maintenance fees on certain accounts, and wire transfer fees. They also charge origination fees on mortgages and loans, which is a percentage of the loan amount charged upfront.

Larger banks also earn money from investment services. They manage retirement accounts, sell mutual funds and stocks, and charge advisory fees. Some banks have trading desks that buy and sell securities for profit. Investment banking divisions help corporations issue stock and bonds, earning fees on those transactions. These revenue sources vary widely by bank size—a small community bank might earn almost nothing from investments, while a large national bank might earn billions.

Capital raised through bonds and stock

Banks also raise money by issuing bonds, which are loans from investors to the bank. When a bank issues a bond, it promises to pay the bondholder interest over a set period and return the principal at maturity. This gives banks access to long-term funding without relying solely on deposits. Bonds are attractive to investors like pension funds and insurance companies that need stable, predictable returns.

Banks also raise capital by selling stock to the public. When you buy shares of a bank's stock, you own a small piece of the bank. The bank uses the money from stock sales to strengthen its balance sheet and meet regulatory capital requirements. Unlike bonds, stocks don't require the bank to pay interest, but they do give shareholders voting rights and a claim on future profits.

Regulators require banks to hold a minimum amount of capital—money that belongs to the bank itself, not depositors—as a safety buffer. This capital must be large enough to absorb losses if loans default or investments decline in value. Banks raise this capital through retained earnings (profits they don't distribute to shareholders), stock sales, and bond issuance.

How the Federal Reserve influences the money supply

The Federal Reserve doesn't directly control how much money banks lend, but it influences lending through interest rates and reserve requirements. When the Fed wants to encourage borrowing and spending, it lowers the federal funds rate, making it cheaper for banks to borrow. Banks then lower the rates they charge customers, and more people take out loans. When the Fed wants to slow inflation, it raises rates, making borrowing more expensive and discouraging lending.

The Fed also conducts open market operations, buying and selling government securities to inject or remove money from the banking system. When the Fed buys securities, it pays banks with newly created money, increasing the amount banks have available to lend. When it sells securities, money flows out of the banking system, reducing lending capacity. During recessions, the Fed buys large quantities of securities—a practice called quantitative easing—to flood the system with money and encourage lending.

What happens when a bank runs out of money

A bank run occurs when many depositors withdraw their money at the same time, faster than the bank can access its reserves or borrow replacement funds. Because banks lend out most deposits, they don't keep enough cash on hand to cover a sudden mass withdrawal. If depositors lose confidence in a bank's stability, they rush to withdraw, and the bank can collapse even if it's technically solvent.

The Federal Deposit Insurance Corporation (FDIC) protects against this by insuring deposits up to $250,000 per account holder per bank. This may provide reduces the incentive for panic withdrawals because depositors know their money is protected. The FDIC also steps in when a bank fails, either arranging a sale to another bank or paying out insured deposits directly. This system has prevented widespread bank runs since the Great Depression, though smaller runs still occur occasionally when confidence in a specific bank erodes.

Frequently Asked Questions

Why do banks pay such low interest on savings accounts?

Banks pay low rates because they can borrow deposits cheaply. When the Federal Reserve keeps interest rates low, banks have little incentive to compete for deposits by offering higher rates. They can lend that money out at higher rates and keep a large margin. When the Fed raises rates, banks gradually raise savings rates too, but they lag behind because banks want to protect their profit margins.

Can a bank lend out more money than it has in deposits?

Yes, through fractional reserve banking. A bank with $100 million in deposits can lend out $90 million (if the reserve requirement is 10 percent) and still have $10 million in reserve. But it can also borrow from other banks or the Federal Reserve to lend out additional money. The total amount a bank can lend is limited by its capital, not just its deposits.

What happens to my money if a bank fails?

The FDIC insures deposits up to $250,000 per depositor per bank. If your bank fails, the FDIC either arranges for another bank to take over your account or pays you directly from the insurance fund. Amounts over $250,000 are not insured and may be lost, though the FDIC often recovers some of that money by selling the failed bank's assets.

Why do banks charge overdraft fees if they're lending me money?

Overdraft fees are not interest on a loan—they're penalties for violating your account agreement. Banks charge them because overdrafts are expensive to process, create risk if the account stays negative, and generate revenue. Some banks offer overdraft protection, which links your checking account to savings or a credit line, preventing overdrafts but charging a fee for the service.

How does the Federal Reserve create money?

The Federal Reserve creates money electronically by crediting bank accounts. When the Fed buys securities from a bank, it doesn't hand over physical cash—it transfers digital money to the bank's account at the Fed. That money then enters the broader economy as banks lend it out. The Fed can create money without limit, but doing so risks inflation if too much money chases too few goods.