How do banks make money?

It’s something we get asked about quite often — how we make money — usually preceded with a dubious “other banks charge fees that Starling doesn’t— why is that?”

So here it is, the blog post for you to answer that very question. In UK retail banks, there are typically four main income streams.

Net interest income

One of the primary ways — at least for traditional high street retail banks — to make money is through net interest income (“NII”). It’s a pretty old school method, but it works: every bank takes and holds customer deposits, either through current accounts or term deposit products, such as fixed term savings accounts or ISAs, and this produces interest income. Banks then lend a proportion of these deposits out to customers, as overdrafts, term loans, mortgages and other products and this produces interest expense. It is the sum of these two figures that generates net interest income, which is effectively the excess interest generated by banks from lending customer deposits to other customers through overdrafts or other lending products, less the interest it pays customers on deposits.

To put it into context: say a Starling customer has £2,000 in their current account — a portion of that money is used to provide overdraft lending to other customers. In turn, we pay you 3.25% AER* / 3.19% Gross* (variable) interest on that deposit. If you’re already a Starling current account customer with an overdraft, you should be aware of our simple 15% EAR overdraft**. We don’t charge fees on top of this, so it’s simple and transparent to you as a customer.

Having said that, to make sure that we never find our customers queuing around the block in Finsbury Avenue chasing their money, Starling, like any other bank, will hold a certain amount of customer deposits in cash and other high quality liquid assets in order to provide enough liquidity (i.e. readily withdrawable money). This means that you can continue to access and withdraw your cash wherever you are and whenever you need to — no problems.

Treasury income

This generates another (far more modest) source of income for Starling known as treasury income. At Starling, we believe in stability and transparency, so our excess deposits that we don’t lend are held on deposit at the Bank of England and a proportion of this is held in UK Government Securities — more commonly known as gilts. Gilts have been around for hundreds of years; allegedly the first gilt was issued in 1694 when King William III borrowed £1.2m to fund a war against France. Nowadays, it’s typically considered the most low-risk fixed income investment – sometimes you might hear this referred to as the “risk free rate”.

Interchange income

Interchange income is a transaction-based revenue that banks, like ours, receive each and (almost) every time you use your card to buy things. In each case — whether you’re tapping to make that daily coffee purchase or treating yourself to a couple of Thursday night drinks — the merchant will pay a small fee: the majority of this will go to the card issuing bank, while the rest will go to the merchant’s acquiring bank.

Fees and commissions

This is where a bank’s profit and loss becomes more interesting, particularly in the case of Starling. Usually, this is where a typical high street bank will include any fees they have generated, commission they have earned relating to financial products, or where a bank might recognise fees on a premium account offering that charges a monthly subscription.

For most traditional banks, this will be as a result of cross-selling or upselling their own financial products, such as packaged current accounts, mortgages, credit cards and personal loans — you know, those pesky emails and letters in the post that you might find yourself receiving on a regular basis!

It’s a little different at Starling where we only offer one product — a current account — but we acknowledge that a current account might only be a part of many people’s financial profile. Since we’re all about helping to give everyone the opportunity for a healthy financial life, it doesn’t mean you should miss out on offers of other complementary products and services — that’s where our personal finance Marketplace plays a part.

And this is how Starling can make fee and commission income, as some (but not all) of our partners will give us a percentage or flat fee for every sign up made through our Marketplace. However, as our Marketplace grows and in order for you to have true clarity and control, we’ll explicitly let you know if that’s the case before you decide to connect to these products and services. (We’ll also never be pushy — they’re just there in Marketplace to provide you with choice if you decide to go that way.)

While banks won’t invoice you to step into their branches, the obvious overhead costs are much more so than a branchless bank like Starling (where we aim to offer all your online banking and branch services through the mobile app) — that’s why you may come across many banks that charge for overseas ATM fees, unarranged overdraft fees, and more. Many of our customers have grown accustomed to a complex host of fees, but our profit margins don’t need to be as bulky as traditional banks as we’ve changed our business model to be as balance sheet lite and capital efficient as possible. This is one of the many benefits of being an agile, mobile bank — which can only be better for our customers.

*AER stands for Annual Equivalent Rate and illustrates what the interest rate would be if interest was paid and compounded once each year. Gross is the contractual rate of interest payable before the deduction of income tax at the rate specified by law. See illustrative example.

**Please be aware that from the 1st April 2020 our overdraft rates will be changing. Discover our current rates.