Eli5: How do banks consistently make a return on the customers money they invest?


You can’t withdraw all your money from your bank account because it is constantly being invested and reinvested, but how come banks are never ‘down’ on these investments in the same way the average person is with their investments? Are they protected by government guarantee so they can just reap huge profits by investing constantly without risk?

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For the most part, banks invest in items that are low(er) yield and lower risk. This allows them to consistently turn a profit and ensure they don’t violate their reserve requirements if there is a substantial swing in stock value.

A bank’s primary method of earning money is the issuance of loans. Right now, the yield on a 30-year fixed is 8.13%. After they pay out interest on their accounts (which can be as high as 4% these days), they are still clearing over 4% as profit. Notwithstanding the housing bubble a few years back, home loans are fairly low-risk investments (as there is a valuable asset backing the loan which can be sold in case of default). It is very difficult to lose money on home loans.

Now, of course, that isn’t going to get you the same yields as the market (the S&P 500 is up almost 15% this year) but the less risk you take, the less reward you potentially get.

Who told you that you can’t withdraw all of your money from your bank account? Unless you are invested in mutual funds or stocks and if you are talking about a typical checking or savings plan, you absolutely can take all of your money out whenever you want.

They don’t. They make more than they lose. That doesn’t mean it’s consistent. Also, plenty of banks have gone out of business.

Some of their income is also risk free. Fees on accounts for example. Or it’s loans secured by collateral that they’d get to keep and then sell and make a profit on anyway if the loanee defaults.

They loan it out to people who have good credit and are likely to make on time payments. Then they also have insurance in case people default.

The numbers are setup in a way that even if some people default it’s still a net positive.

Deposit banks and investment banks are different things. A big part of the financial crash in ‘08 was allowing deposit banks to act like investment banks.

Deposit banks pay you interest on your deposits. They loan out said deposits for a higher rate than they’re paying you. What does your bank currently pay for your savings account? Now go look up the rates they would charge you for an auto loan. That’s how they make money.