How Banks Work (And How They Make Money Off You)

0:00 We know a lot of people who have not the best credit scores, they've been delinquent or they've been late. So then they get the late fees. And the late fees can be anywhere from ten, twenty dollars or they can be thirty, forty dollars, depending on the bank. So a lot of people who don't have all the liquidity in the world, they're getting hit up both directions maintenance fees and late fees from the credit cards. And the banks and the credit cards, the visas and the Bank of Americas and the world, they're making all this money from you guys. They make a lot of money from people who don't have a lot of money. It's crazy, isn't it, Shabazz? It is. They prey on the people you know that have the poor money mindset. So it's really predatory.

1:13 This is Darren Harvey. I'm your gracious host of Financial State of Minds, and I'm joined by co-host Marie Shabazz. And this is the show where we help you get to that bag, manage that bag, and grow that bag as best as possible as we discuss financial and business literacy and anything and everything to do with the almighty power of the dollar. And this show is, of course, being hosted on KGPC96.9.org. It's this where you can stream it. And of course, radio frequency is 96.9 and available on all of your favorite platforms of choice for streaming. So today's topic. It's going to be a 30-minute episode, short, but I think it's going to be very important we talk about this to make this clear to people.

1:55 Topic of the day. How does a bank work? How does a bank work? So that's the topic for the day. How a bank works, how it makes money, how it does business, all that stuff. So I wanted to just talk about this a short 30-minute episode because most people do not understand how a bank works. And works means how does it function? How does it make money? What are some of the rules and regulations around it? How does it work? So, of course, I'm joined by Shabazz, who's been in the game 20 plus years, so he's gonna know a thing or two about this subject. So, Shabazz, I will let you start off with things. So, if someone were to ask you, hey Shabazz, how does a bank work?

2:38 How would you describe it for him? Well, it's a good question because a lot of people don't really think about it. So, great topic. So, how banks work, most people think believe that let's say they get a 30-year mortgage and at a certain percentage rate, right? This is the thing. Most people still believe that the bank is waiting 30 years to get their money, right? With interest, right? And that's not how it goes. So probably a great example is the housing crisis back in 2000, 2007, 2008.

3:19 So when the housing market crashed, this is what happened. So before I get into that, banks are not gonna wait for in the in the scenario of a 30-year mortgage, they're not waiting for 30 years to get their money back with interest. What they do is they package up that loan and they sell it. And they might sell it overseas to another bank or whatever, and but people be like, well, but I'm still paying Bank of America, I'm still paying Chase Bank, I'm still paying such and such mortgage. Yeah, because now that bank has to pay them to service the loan. So they make money to service the loan, and they also make money by papering up, packaging up that paper and selling it for a profit.

4:03 So what happened in the housing crisis is that the loans that were made, it wasn't good paper because a lot of the loans that were made at that time, the underwriting of criteria just did not fit people who could actually pay back those loans. So a lot of that paper was bad. And what happened was is that banks overseas said we're not buying your paper because a lot of these loans are being defaulted on. And so when they automatically stop buying these packaged loans, everything came to a halt. And that's what caused the housing crisis. Right, right.

4:44 So let's pull back a little bit. Let's just break it down like the listener may not know anything. So let's first start off like this. So there's your bank, and most people think of a bank, they're thinking Bank of America, Willis Fargo, Chase, Citibank, Capital One. Those are the big national American banks, basically. Right. So let's stick with that. Of course, there are regional banks. Shout out to Patelco, that's who I bank with. There's like a Fremont bank. So those are regional, they service just a city and region around it. They're usually not national. And there's a third one, online only banks. Those are the ones that there is no brick and mortar, the entire company is operating online.

5:29 There's no way you can go into a branch and ask for anything. Those are online-only banks. So we're gonna focus on those three for this short conversation. Now, let's talk about okay. The bank houses your money, right? So you put a deposit, whatever, you have a couple thousand dollars in your savings account, and they collect that for nationwide, or if it's a national bank or a regional for citizens around, let's just say the Bay Area, they're collecting all these people's money. So let's talk about how the banks are actually what their services are, how they're making money. So you just said one of them. They're lending the money out, right? So you're right.

6:09 They aren't sitting and waiting around for 30 years if you get a loan from a bank, um, when it comes to a mortgage, they're not waiting for the whole 30 years. You just you nailed it. They are getting paid for servicing and packaging of it. So that's one way they make money. The other way they make money is of course, well, fees. So especially national banks, national banks, unless you have a certain amount amount of money sitting there, or do you do a certain amount of transactions, the accounts aren't free, right? It's$10 maintenance fee,$25 maintenance fee,$50 maiden fee, whatever it is, depending on the type of account, checking, savings, personal business side.

6:53 So they offer other type of services too. They offer investing type of services. So simple high yield savings account, simple CD accounts, those are other ways that they offer a service, right? So, Shabazz, how is the bank making money with the money that the everyday person is depositing into their account? How are they making money that way? Well, they're loaning that they're loaning that money out. Right. So, yeah, they have something called an LDR, it's a loan to deposit ratio. Right. So what happens is that you could just about usually the banks have a 80% rule.

7:40 That's usually where they cap, where they will loan out 80% of their liquid, right? Up to 80%, right? And some banks are sitting at 70%, but of course the banks go above that. And usually when they go above that, they're in the red flag zone. And that's why you probably people have probably seen where the government has had to belt, the Federal Reserve had to bail out the banks, because they went above the loan to deposit ratio, and now they don't have enough liquid to actually cover, especially in case of people start defaulting.

8:23 Like if there's a high percentage of defaults on loans, then basically they're in trouble because their loan to day loan to deposit ratio is so high. A good movie, man. I can't even think of the movie. You might know the name of the movie where the two brothers opened up a bank. It was back in the mid-1900s. Samuel L. Jackson played in it, and um, I forget the name of the other actor, the other brother. You know what I'm talking about? I know what you're talking about, but I can't think of the name of the movie myself. I don't think I've seen it. But that was the reason why they had to go to jail. Right. Because they the amount of their loans, the LDR, the loan to deposit ratio. That was the reason.

9:04 Yeah, so my understanding I might be wrong is federally the banks are required, they have to have, I think it's 10%. So 10% of whatever total amount of assets or or or whatnot, basically money they have, it has to be readily accessible at all times, liquid, aka liquid. It needs to be 10% of their money needs to be liquid. It's mainly my understanding is withdrawing, right? So that they can that people can withdraw their money and the money's actually there. The money, the actual currency is there. Right. What happened with a lot of these bank closures that happened in, I think what, 2022, 2023, even 2024, and before is what essentially a withdrawal or a banking withdrawal run.

9:49 And then what happens is it's usually tied to the market, but basically a wave of people withdraw their money at the same time. And same time being within a couple of days, within a week, within two. And what's happening is they're withdrawing over that 10% or 20%, really should be 20%, but I think federally they can do 10%. They're withdrawing too much of that, and therefore the bank can't no longer give out its money and it starts to collapse based off of that. There's other factors too that can cause a bank to collapse, but that's a lot of times is the is the big trigger point is those withdrawals and it comes from the market, which leads to another way banks make money.

10:35 If people are wondering, okay, Darren, I have a savings account. It could be with Bank of America, it can be with Patelco, it can be with an online bank. They all offer savings accounts. Some of them offer high-yield savings accounts, but all of them offer some type of savings account. And of course, we always make fun here on the show. You know, ha ha ha, Bank of America is only offering a 0.0005 return on your money, or, you know, maybe a one full percent if, you know, you have a certain amount of money deposited in the account. But then there's other smaller banks like a Patelco that are currently offering three, you know, under certain conditions, a 3.5 under certain conditions, conditions.

11:18 Usually it's just how much money you have in the account. They offer that, they can offer something higher. Okay, well, think about it. If they're giving you, at best case scenario, a three, a three and a half, they're still making money. So how are they making money? Well, they're making money because they're investing your money. So banks invest. That's one of the biggest ways they're making their money, is they invest your money. Like Shabazz said, only 20% needs to be liquid. The other 80% is where? It's in assets. Assets being investments. Usually it's the stock market, but it can be real estate, obviously, because they're handing out mortgage loans.

12:01 But they're investing the money, they're investing all of our money. That is one of the biggest ways banks make money. They're simply investing the vast majority of money that we are giving them to hold for us, and they are giving us a differently, essentially a small cut, a very small cut of those profits. So I say if they're making, you know, if they're giving you 3% on your savings account, somewhere that money invested is getting, they're getting like an eight, they're getting like a seven, they're getting a 10. You know, that's true. Again, we all know, if you're a listener to the show of any length, you know that I always push the S P 500 and the SP 500 over the last 100 years averages an 8 to 12 percent.

12:48 So the banks we can definitely say is getting an 8%, at least they're getting 8%. And if you're at a regional bank, you're getting a three return. And if you're at a national bank, you're getting what? Again, a 0.0005 in return. They're making a gang of money investing your money. So that's another way banks make money. Um, Shabazz, what are other ways that banks make money? So, of course, investing. They invest in so many different things. You you hit it right on the head. Um, like they make money by with fees. You think about all the fees, a lot of checking accounts, they're not free.

13:29 A lot of uh, a lot of people that basically are living check to check, they have a lot of NSFs and insufficient funds, and they're getting charged anywhere up to close to 40 bucks for each NSF that they have, right? And they make a ton. I did some research on how much money that these national banks make from not in NSFs, and that number was like astronomical. Astronomical. So they make a ton of money for you not having money, right? You don't have money, but they're making money. And as soon as you get it, boom, they take it.

14:10 Because you need your checking account at the end of the day, you might have direct deposit or whatever, but people need their bank accounts, right? So, yeah, and there's so many different fees. There's hidden fees, too, that people don't even know about, they don't even pay attention to, you know, for different transactions, and people aren't even really paying attention to their bank statements or really analyzing it from that standpoint, and people are just going along with their everyday life and not really understanding. And and this is the thing. They're making so much money off of their money, the people who actually bank with them and deposit money into the bank, they're making so much money off of your money because they're lending out your money.

14:53 And this is the other thing. A lot of man, there's people that live their whole life and never get a loan from the bank. The bank that they bank with, the one they've been with for the last 10, 20, 30 years, they never get a loan from their bank that supposedly that they have a relationship with. And so you're depositing money into this account, you're a faithful customer, they're giving you less than 1% interest on your money, especially if you're with a national. If you're with Bank of America, if you're with Chase, Wells Fargo, Citibank, basically they're giving you less than 1%.

15:35 And then they're lending out money, so they're basically lending your money out. And the bigger the bank, the less they give. That's the thing. And that's what people don't understand. Smaller banks, yeah, there's more benefits. The bigger the bank, the lesser the benefit. You know, I I I can't forget, I forget who I got that terminology from, but somebody said it, and it was it's right, it's spot on. But banks make money several different ways off of your hard-earned money. Yeah, so I wouldn't go into I'm gonna literally list them. Fees. You're right. They make so much of their revenue off of fees, it's crazy, to the point where they have to regulate it. I know I'm not sure federally or state of California regulated to where they couldn't charge a certain amount of dollars for certain fees.

16:18 It was so high, and they're making so much money off of these fees. But okay, we take calling we've named a couple of them, but let's just list them so you guys have it in list form. Fees include your checking account, your business account, maintenance, just maintenance. So you can be a perfect person that always has money in there, and you're still getting charged again a$10 a month,$15 a month,$20 a month,$50 a month. You know, on the business side, it definitely gets higher a month just for maintenance. Then, of course, that's if you have the money. If you don't have the money, that's where they really get you. You get charged for overdraft fees, you can get charged for not having enough money in the account, you can get charged for having too many or too little transactions in the account, all the hidden fees that you mentioned.

17:09 Hey, you didn't have a certain amount of money within a span of 30 or 30, 60 days, the calendar month or the cycle, the banking cycle. There's that. So there's all the ways from just basically the liquid side, the liquidity side, they charge you a fee. But there's one thing that they could be making money off of that I'm sure everybody kind of wonders about too. So Shabazz, you're the leader in this. I'm gonna ask you, what does the relationship look like between the credit cards and the banks? So I'll pull it out for the viewers to see. But I have a Bank of America credit card.

17:53 And if the viewers can see this, it has Visa on it. So we all know that Visa is not Bank of America, but we all associate credit cards with banks. So Shabazz, can you break down how money is being made with between Visa and Bank of America when they issue me this credit card? Oh man, credit cards are the worst. Well, I'm not gonna say they're the worst because that's what everybody believes, or what most people believe. If they're used a certain way, they definitely can be beneficial. But when it comes to fees, if you're on the other, if you're on the losing end of that scenario where you're not in a position to pay off your balance every month, you are subjected to a ton of fees.

18:43 Well, I mean, the average interest rate, the average annual percentage ratio for credit cards right now is anywhere from 15 to 20 percent, right? That's just average. Some of them go up. I'm gonna say it's higher. I wouldn't say it's about 20, 25. Right. Yeah. So yeah, and then you have uh some that goes up to almost 40 percent. Yeah, yeah, there's 30% credit cards nowadays, you guys. There are 30% credit cards interest rates. Yeah, so if you have bad credit, and people always say, what is bad credit really costing you, right? So I always tell people, man, it's a hundred percent beneficial to get your credit rating in a good place because you're subjected to so much more when it comes to fees and when it comes to interest.

19:23 And then they have maintenance fees, they probably credit cards, I don't know for sure, but I would probably imagine they have more fees than the actual bank. Yeah. Yeah. So um they do. So, and people say, Well, I've been paying it, but the balance never goes down. That's because it's so many fees, right? And plus, with the interest, along with the interest, so you got fees and you also have interest. So having a credit card balance is not in your benefit at all. So if you could pay off the balance each month, of course, you're not subjected to all those things. You're still gonna be subjected to fees, you know, but you won't be subjected to the interest.

20:06 And the interest is the biggest killer. Yeah. So I'll kind of Shabazz is headed to the right direct direction. I'll kind of make it kind of more concise and clear. So I actually still am not 100% exactly how fees and services get split up between, we'll use the example Visa and Bank America, but I'm relatively confident this is how it works. Visa is essentially the servicer, in a sense. So when you make a transaction, yes, listener, you're not paying for that. Usually you're not paying for that transaction. It's the person receiving the money that pays the uh transaction, which is usually a business.

20:50 So a business owner is paying a fee just to make that transaction happen. Visa is the highest, they take more of a fee than MasterCard, than American Express, then Discover is the big four. So they take a fee. And that fee is determined based off of your location. So your fee is going to be different if you're United States of America compared to if you're in Australia and who the transaction is coming from. So if it's US to US, that's one fee. If it's US to Canada, that's one fee. If that's Canada to Germany, that's one fee. They're all different. So there's a fee associated with just a transaction.

21:30 And then my understanding is that the issuer, so that's different. So visa visa is not the issuer. Bank of America, in this example, is the issuer. So the issuer makes some type of money from all the fees that are happening. So I don't know the exact details of where each fee goes to which person, but between the two, that's right. When you don't pay your balance in full and you gain that interest. Visa and Bank of America are making money on that. When you miss your payment and you're late or you're late, Visa and Bank of America are making money off of that.

22:11 And the amount of money that these companies make off of just being late, just having a balance that's not paid off in full, is insane. Remember, the average credit card, I believe Shabazz is actually right now that I'm thinking about it. It's around like a 20, 18%. That's average. Well, that's just because a lot of people have good credit. Most people who have bad credit, they're hovering 25 plus. 25 plus, if you divide, let's just make the math easy. If you divide 24 between 12, 12 being the months and the year, you're paying 2% per month because you didn't pay what you borrowed off in full by the end of the month, by the end of your 30-day cycle.

22:54 So there's a fee. So let's just do some simple math. You had$1,000 in your balance. 2% of$1,000 is$20. Well,$20 times$12 is$240. Now you've had to pay$240 extra just because you had the balance. And that's if you're on time. We know a lot of people who were who have not the best credit scores, they've been delinquent or they've been late. So then they get the late fees associated with. And the late fees can be anywhere from$10,$20 or they can be$30,$40, depending on the bank. So a lot of people who don't have all the liquidity in the world, they're getting hit up both directions.

23:38 Maintenance fees and late fees from the credit cards. And the banks and the credit cards, the visas and the Bank of America's and the world, they're making all this money from you guys. They generally make a lot of money from people who honestly don't have a lot of money. It's crazy, isn't it, Shabazz? It is. They prey on the people, you know, that have the poor money mindset. Right? It's really predatory. And that's probably the perfect word for it. It's predatory. Because the people who are working check to check and basically are not in position to pay down large amounts of debt. Right. Those are their ideal customers.

24:20 Right. So it's crazy when you really think about it. Yeah. And that's why I always stress to people. And I try to, not well, not even just me, just you, and just try to reprogram this whole money mindset. Because every time I talk to people about credit and credit cards, right? I always ask people, like, what is credit used for? What is the primary, what should be your primary use of credit? And people never, ever get the question right. They never get the answer right. When I ask that question, and what happens is I tell them, credit, you should only be using credit to make more money.

25:07 And especially if you're in a position where you're working check to check. You definitely don't need to be financing anything that you can't afford. You right? So the credit cards, man, they could be a tool. They could be useful if you have the discipline. But if you don't, they're the worst thing ever. And a lot of people were trained, like a lot of people were taught. Because we get our financial education from our parents and stuff like that. Right. Because they didn't really know. So they told us to stay away from credit cards. Don't get any credit cards. Stay away from credit cards. And like they were the worst thing ever. And essentially they can be. They really can. But they only got the bad side of it. They never looked at all the other benefits to it.

25:48 There are benefits if you know how to utilize credit cards. But like I said, it goes back to the mindset. Right, exactly. So it's a shorter episode, so we're already near nearing the end of the episode. But I want to rattle off a few kind of quickfire ways banks make money, and then we'll kind of wrap it up. So, like I said, summary so far what we talked about, credit cards and their partnership with the visas, the master cards of the world, they make money that way. They make money with all the fees, which includes maintenance, which includes late fees, which includes over withdrawing, which includes not transacting or having enough money. They make money, of course, through lending the money and you borrowing the money from a bank.

26:30 Other ways they make money is the total landscape of investing. So not only are they, I said earlier, that they're investing the money that you give them for their own personal gain, the company's personal gain, they also make money offering those services to you. So you can go to a bank and find an entire investment department, whether you're using a CD account to help them make money, you get a little bit higher cut, or literally you hire or you use their investment managers and they manage large amounts of money that are getting invested into the market, they're making money that way. And that's just again, some of the ways the bank makes money.

27:10 And it's a small, small start to how these banks work. The point I want, and the reason why I want to talk about this this concept of how the banks work is one, most of you guys listening didn't know what we just talked about, and two, you have an understanding of the banks. And the banks, trust me, they will be completely fine if you don't give them their money. They will be completely fine. Banks, especially the national banks, are some of the safest places to invest into as a company because they've been around forever. And what have we seen, listeners? We will see that the feds will bail them out.

27:53 Yeah, they'll bail them out. So a lot of people ask me, hey Darren, what companies should I invest in? They're not the fanciest, they're not the flashiest, they won't give you the highest return on investment. But if you want to think about safe companies to invest in, banks, they're not going anywhere. You never have heard Bank of America, I would say, is a bank that's pretty much too big to fail. Wells Fargo is a bank that is pretty much too big to fail. Not because they have so much money housed, but because we know that if those two particular banks fail, the federal government's gonna bail them out. We know that. We basically know that it's gonna get bailed out. So going on and on an investing note, you guys are looking for some companies to invest in where you're not worried about that money going from$100 to zero overnight, put into Bank of America, put into Wells Fargo.

28:39 They may not be the best banks service-rise, but the point of a company is to make profits. And those banks are absolutely profiting, and they're profiting off of your money. So, what can you do to take advantage more of your bank? Um, again, I would check into online banks and we can make an uh follow-up episode on advantages between national banks, regional banks, and online banks. But typically, online banks offer either lower fees or no fees for a lot of the stuff we've talked about. They offer more favorable terms when it comes to the credit cards. They offer slightly different interest rates. And there's other advantages that regional and online banks have compared to their national competitors.

29:23 So that's it. We're out of time. This has been Darren. This has been Marisha Bass, Financial State of Minds. This has been a show where we help you get to that bag, manage that bag, and grow that bag as fast as possible. Wow. This has been the show where I help you grow that bag. Wow, I'm off today. Get that bag, manage that bag, and grow that bag as best as possible. Jesus Christ, that was horrible. And we're gonna keep that all in because that was hilarious. And um, thank you guys for tuning in. And you've been listening to that screw up on AGP Steam 96.9 FM, if I say that correctly, and streaming on AGPST96.org, if I say that correctly, and available on the comedy baby.

30:19 Anyway, I'm gonna