In finances, there is a term called spreading or spread. In general, spreading within financial institutions means transferring complicated financial statements into a more digestible format—a process known as spreading financial statements. Regarding banking, spreading has to do with interest rates and how banks make most of their revenue. Continue reading to learn more about banking spread and how it can impact you as a bank customer.
The Basics of Bank Spreading
As mentioned earlier, spreading in banking has to do with interest rates. More specifically, interest rate spread refers to the difference between the interest the bank pays to their customers (usually through accounts like savings) and the interest rate charged to borrowers. This net interest rate spread will be included when calculating a profit margin. And so, the interest rate spread is a good measure of a bank’s and other similar financial institutions’ profitability.
How Do Banks Determine Interest Rates With Bank Spreading?
The interest rates for bank loans and deposits depend on different factors, including the federal reserve bank, which sets monetary policies and market conditions. On a more micro level, banks determine interest rates by account types and the consumer’s creditworthiness (for loans).
An Example of Spreading in Banking
Here is an easy-to-understand example of how financial spreading with a bank works:
Let’s say that you have a checking account with a bank, and you get a .03% interest rate on your return—close to the average interest on checking accounts. That money is then pooled into an account that the bank lends from. Now, suppose another customer goes to the same bank to get a personal loan. In that case, the interest rate for the loan will likely range from 10%-30% (depending on the financial institution, borrower’s creditworthiness, market conditions, etc.). As you can see, there is a pretty significant difference in the interest rate paid vs. the interest rate charged—this is the profit margin for the bank.
Does Bank Spreading Mean That I Am Getting Ripped off if I Borrow From a Bank Loan?
Seeing a profit margin of anywhere from 10% to 50% may seem alarming, especially if you are the one borrowing money from a bank loan. However, that is pretty normal. Banks operate just like other lenders and have to make some profit somehow. On top of that, the interest rates for a bank loan are set just like similar lending options.
For example, a credit card’s interest rate throughout the board ranges from approximately 20% to 30%, and you will find those with bank credit cards. Another thing you must consider is that the bank has to provide that money back to their banking customer if a borrower defaults on their loan, which can happen all the time. And finally, the costs of operating a bank can be extremely high, especially for a commercial bank, so all of these things have to be considered when determining how to make a profit.
And so, the short answer to that is no; you are not necessarily getting ripped off simply because of spreading in banking. To get the best deal on a loan, credit card, or other financial product, you must compare your options and consider what you can get depending on your credit standing.
What Other Ways Do Banks Make Their Money?
Spreading is one of the significant ways that banks make their money, but there are a few other ways that most banks make their money; here are examples:
Money from Banking Fees
Bank fees are another significant source of income for banks. If you have had a standard checking account before, you probably have experience with one or more of them. Here are some examples:
- Basic Account Fees — To keep a checking, savings, or other bank account type open, you may have to pay a monthly fee. Often, this fee can be waived for students, seniors, or based on banking activity.
- NSF Fees — Non-sufficient funds fees or NSFs happen when you spend more money than you have in your account and your bank account goes negative—which can really hurt your finances. Each day you go without correcting a balance, the more fees your bank can add to your account.
- Overdraft Fees — You can pay to have overdraft protection in place when you sign up for a bank account. Overdraft protection stops your bank account from going into negative if you spend more money than you have. Instead of an NSF fee, the bank will charge you the overdraft fee.
- Transfer Fees — With savings accounts, your bank will likely limit the number of transactions/money that can go out of it for a month or period. With some checking accounts, you may also have guidelines for the number of transactions that can happen. If you go beyond the allowed limit, you may face a transfer fee.
- Account Closure Fees — Another fee that can occur to banking customers is an account closure fee. If you have opened your bank account in the last month or so and then decide to close it, there may be a penalty.
- Minimum Balance Fees — For many savings accounts, you will find that you will be required to keep a minimum balance. If you go under that amount, your bank will charge you.
Profit From Large Loans
Most people know that banks have credit cards and personal loans, but they may not be aware that many large commercial and regional banks also offer long-term loans. These larger loans are another big money maker for banks and financial institutions like credit unions. Here are some examples of the types of loans that banks may offer:
Mortgages
Mortgage loans are used to finance a property and are usually 15 to 30 years long. Homebuyers can expect to pay their mortgage lender monthly until their loan is completely paid off. Not all banks offer mortgage loans, but many do, and it is becoming increasingly more common as the demand for different types of loan options increases. A bank can look forward to potentially making a steady profit for several years by securing a mortgage customer.
Car Loans
Car loans are about three to five years long and provide financing for a vehicle purchase. Many dealerships also partner with certain banks to offer the best financing options for their customers.
Business Loans
Business loans are another commonly used loan option by customers. Because starting and running even a small business can cost thousands, many people head to a bank, where they know the right amount of funding will be available to inquire about. Another thing a bank can look forward to with business owners is building a long-lasting relationship. So, as their business grows, the bank can be there for their future lending needs.
Student Loans
Although federal student loan programs are the first funding choice for students, not everyone has access to them. Banks can offer student loan options, and with a cosigner, these loans may even be available for borrowers with no credit history or a low credit score.
Revenue From Retirement Accounts
Many people use 401ks for their retirement, but those who do not have this option may opt for IRAs or individual retirement accounts. Many banks offer these long-term savings accounts.
Offering Investment Opportunities
Banks also charge money to help banking customers who want to learn more about investing. They can sometimes also do the investing for you.
Financial Advising Services
Many banks hire financial advisors or planners to help customers understand their money better. A financial advisor can help you look at your money to develop budgets, financial plans, and investment strategies.
Can Bad Credit Borrowers Have a Bank Account or Borrow Bank Loans?
Yes, even with bad credit, you can get a bank account and potentially borrow from a bank loan. When it comes to a standard checking or savings account, there will likely be no credit check to qualify! And so, even with bad credit or no credit, you should be able to open up an account if you want to! However, bank loans can be a little more complicated with poor credit.
When looking for bad credit loan options, you may encounter high-interest options like payday loans online or car title loans. And although those options can be tempting because they allow you to get your foot in the door, they can be expensive and lead to debt. Personal loans, on the other hand (from a bank or private lender) may offer more reasonable loan terms.
It is crucial to keep in mind that each bank and lender has different eligibility requirements, so just because one denies you, doesn’t mean that you won’t get funding from another—especially if you are already a banking customer with them.
The Key Points to Bank Spreading
Bank spread is the difference between the interest a bank pays and the interest rate a bank charges. The process is one way that a bank makes most of its profit. As a consumer, it may seem a little unsettling to see that stark difference, but you should know that bank loans are regulated and are likely similar to other options in the market. Before taking out any loan, looking around to get the best deal is essential.
References:
Net Interest Rate Spread – Overview, Example, Importance
Guidelines for Spreading Financial Statements
Here’s how banks check your credit when you apply to open a checking or savings account
