How Banks Make Money: The Short Version

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The banking business can be quite complicated, but at its core, there are two main types of banking operations: commercial banking and investment banking.

In this clip from Industry Focus: Financials, host Shannon Jones and Fool.com contributor Matthew Frankel discuss the basics of how banks make their money from these two businesses.

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A full transcript follows the video.

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This video was recorded on July 9, 2018.

Shannon Jones: Let's talk about, in a very broad sense, how banks make money and why it's important to understand this.

Matt Frankel: There are two broad categories of how banks make money. The first is commercial banking, which, at its core, is the savings-and-loan type bank -- loaning out customers money, charging interest, and making a profit from the cost of money to you and the cost of money to the customer. That's where commercial banks get their profit margins. On the other hand, you have things like what are known as investment banks, which deal with mergers and acquisitions, they advise on IPOs and equity and debt underwritings. They also deal with the wealth management side of the business.

Those are two broad baskets that you can put banks in. Because these are the big four banks -- they are by far the largest four banks in the U.S. -- three out of the four deal with both of these to one degree or another. It's important to know the distinction, because both have their own risk factors, which we'll get into in a little while, and both have their own makeup in terms of profit margin, what's expected, what's considered good, what's considered bad, how credit quality works with those.

It's important to understand, to start off with, the distinction between commercial banking, which is what you would normally think of when you think of a bank, and investment banking, which is increasingly becoming more of most banks' business these days.

Jones: Exactly right. Key thing here is, it's important for investors to not only understand where a bank is generating its revenue from, but also understanding the makeup of those revenue streams -- as Matt was talking about, consumer banking vs. investment banking, foreign vs. domestic -- and really understanding how they differ in respect to one another. Matt alluded to this a little bit -- of course, when it comes to looking at how the banks make money, how they become profitable, you'll also want to know, just how good are they at lending money to those that aren't at a risk of default? That is a real key area in terms of the quality of their loan portfolios, especially on the commercial side.

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