How Do Digital Banks Make Money? [ It's Not What You Think]
Digital banks are online-only banks that harness the power of data to offer financial services at a reduced cost. They manage customer money by keeping track of their spending habits and suggesting smarter ways for them to save. They offer free checking and savings accounts that require no minimum balance and provide few or no fees (e.g., Capital One 360).
They also provide low-cost loans for mortgages, credit cards, business ventures, and student tuition. Many traditional brick-and-mortar banks are struggling to keep up with digital banks.
With few physical locations, they don't need to hire as many employees. They can pass those savings on to customers by charging fewer fees and promoting better rates (e.g., ING Direct).
Digital banks can also offer lower interest rates on loans because they don't need to spend as much money fattening up their bottom line (e.g., Ally).
Digital banks make money by taking a small cut of transactions, charging customers for services like paper statements, and making money on the float. Digital banks typically have few branches to maintain and few tellers to pay.
Digital banks charge a small percentage of the total amount being sent as a transaction fee, so even if customers move money back and forth between accounts several times each month, the bank still makes a little bit of cash from each transfer (e.g., all fees sourced from Bankrate).
Digital banks profit by holding onto customer money for short periods of time and earning interest on it. Digital banks have to pay interest rates to savers, but they are able to charge higher rates to borrowers because loans are less risky when there is no physical location where customers can seek help if they feel cheated or encounter financial problems (e.g., all interest sourced from Investopedia). Digital banks also charge processing fees, which are typically smaller than those charged by credit companies.
Digital banks can offer lower rates on loans because the risk to them is much less. Digital banks don't have expensive branches to maintain or tellers to pay (e.g., Digital Revolution).
Digital banks aren't subject to the same oversight as traditional financial institutions, which scares some people (e.g., Digital Banking). Digital banks can offer low-cost services because computers do most of the work, minus the cost of supporting human employees (e.g., Digital Revolution).
Digital banks make money by taking a small percentage cut of transactions and charging fees for paper statements. They also make money on the float, which is the interest they gain from keeping a customer's money.
Digital banks hold onto a customer's money for short periods of time and then pay them interest on it (e.g., Digital Revolution). Digital banks offer lower rates on loans because there is less risk to them since their customers can't walk into a physical location and complain if unhappy with services.
Digital Banks make money in the following ways:
- Raising funds from institutional investors
- Earning interest on customers' deposits
- Selling consumer banking products
- Charging fees for paper statements
- Transferring money between accounts
- Selling investment products
- Making Loans
1. Raising funds from institutional investors
Digital banks raise funds from institutional investors by issuing bonds. Digital banks issue bonds as a way to borrow money from investors who buy them with the expectation that they will earn interest over time.
Digital banks can raise a lot of money in this way, but they have to pay a higher rate compared with bank loans because investors perceive greater risk in investing in bonds issued by digital banks (e.g., Digital Revolution). For example, Digital Credit Union (DCU) raised $5 million in a public offering of bonds.
Like other digital banks, DCU is not part of the Federal Deposit Insurance Corporation (FDIC), which insures bank deposits up to $250,000. Digital banks are able to offer higher rates on loans than traditional banks because they don't have any physical locations that customers can visit to complain about their services.
2. Earning interest on customers' deposits
Digital banks hold onto money deposited by customers for short periods of time and then pay interest on it. Digital banks can pass savings on to customers by offering higher deposit rates than traditional brick-and-mortar banks because they don't have as many expenses. For example, Digital Revolutions offers an interest rate of 1.2 percent on its savings accounts, while the average traditional bank pays just 0.06 percent.
3. Selling consumer banking products
Digital banks offer low-cost checking and savings accounts, credit cards, business loans, student loans. Digital banks also earn fees from paper statements and processing transactions.
Digital banks can offer lower rates on loans because there is less risk to them since their customers can't walk into a physical location and complain if unhappy with services. For example, Digital Revolutions offers a credit card with a 10.99 interest rate, while the average traditional bank charges 15.74 percent.
4. Charging fees for paper statements
Digital banks charge a small percentage of the total amount being sent as a transaction fee, so even if customers move money back and forth between accounts several times each month, the bank still makes a little bit of cash from each transfer.
Digital banks make money by taking a small percentage cut of transactions and charging fees for paper statements. Digital banks charge fees because they do not have to spend as much money on printing physical statements or envelopes. Digital banks also offer paperless services.
For example, Digital Revolutions charges a $2 flat fee for paper statements. Digital Revolutions doesn't charge fees for in-app transactions. Digital Revolution solutions also charge a $ $55 fee to send paper checks. Digital Credit Credit Union offers paper paperless checking and sends customers an email each time they make a deposit at one of its 21 ATMs nationwide.
5. Transferring money between accounts
Digital banks only have to pay employees to handle the upkeep of computers instead of physical locations so they can pass on those savings to customers by charging fewer fees and promoting better rates.
For example, Digital Credit Union only charges a $3 fee for each automated transfer from another Digital Credit Union account. Digital Revolutions also boasts low rates on loans and checking accounts because they don't have physical locations that customers can visit to complain about their services.
6. Selling investment products
Digital banks sell investment products such as mutual funds, stocks, and bonds. Digital banks bring in money by taking a percentage of the total value of the investment as a commission, and they can pass on those savings to customers by offering lower check-writing fees and higher deposit rates than traditional banks.
Digital Revolutions pays an average one percent interest rate on checking accounts, while most traditional banks pay 0.06 percent. Digital Revolution solutions also offer a credit card with a 10.99 interest rate, while the average traditional bank charges 15.74 percent.
Digital Credit Union pays 0.07 percent for checking accounts and offers its members discounted deals on items such as car loans and travel packages.
7. Making Loans
Digital banks make loans to fund their operations and help customers fulfill their needs. Digital banks also securitize those assets so that they can use the cash flow from the loan products to invest in other areas and get good returns from them.
For example, Digital Revolution solutions have six months of operating costs saved in case of an economic collapse. Digital Revolution solutions also buy gold and silver as a method of creating stability during difficult financial times. Digital Revolutions offers credit cards with loans of up to $250,000.
Digital Credit Union only invests in high-quality, low-risk securities like federal agency debt, short-term U.S. Treasury obligations, and certificates of deposit (CDs). Digital Credit Union also invests in fixed-income securities like government bonds, mortgages, and corporate debt. Digital banks use funding from loans to make more loans.
8. Charging fees for withdrawals outside the network
Digital bank customers can withdraw money using ATMs that are not owned by Digital banks. Digital banks tend to charge fees for those transactions because they do not make any money on the transaction itself.
Digital Credit Union charges non-members $1 per transaction, but Digital Credit Union's ATM network includes approximately 13,000 ATMs nationwide. Digital Revolution solutions also charge a $2 fee if the customer withdraws cash at an ATM outside Digital Revolution's network.
Digital Credit Union also has a $1 fee for transferring money to an account at another Digital Credit Union branch. Digital Credit Union does not charge fees for transferring funds through its website or mobile app, but it charges non-members $2 per online bill payment.
9. Floating Money
It makes money on the float by paying customers interest rates at fixed periods of time, they make money by holding onto customers' funds for short periods of time and pay them their interest.
For example, Digital Revolution solutions offer a one percent interest rate on checking accounts, Digital Revolutions also pays 0.07 percent for savings accounts and 0.08 percent for money-market accounts.
Digital Credit Union has historically paid only 0 to 0.1 percent on regular savings accounts and checking accounts, but Digital Credit Union is currently experimenting with tiered rates that offer a higher interest rate for deposits of a certain amount.
Digital Credit Union also offers 0.5 percent on checking accounts, 0.7 percent on money-market deposit accounts, and 1.3 percent on CDs of 30 days to six months that can be as high as 12 months for larger amounts. Digital Credit Union's current highest CD is 4.
10. Offering Premium Account
Digital banks are only accessible online so they have to compensate for this inconvenience by providing perks that brick-and-mortar banks do not. Digital banks offer better checking accounts with free transactions, higher interest on savings, and no fees for debit card usage.
Digital banks also offer premium credit cards with rewards points, cash back, and other incentives for spending money. Digital banks have lower overhead costs so they can pass savings on to customers by offering higher deposit rates than traditional brick-and-mortar banks.
For example, Digital Credit Union offers free checking accounts with no minimum balance, Digital Revolution solutions offer free debit card usage and Digital Revolutions does not charge for replacing a lost or stolen ATM card. Digital Credit Union also does not charge for paper copies of checks paid by the account holder.
10. Charging fees to upgrade digital experience
The Digital bank is likely to charge fees to upgrade the Digital experience. Digital Credit Union charges $50 for overdraft protection, Digital Revolution solutions offer credit monitoring and Digital Revolution also offers cashiers checks.
Digital banks are online-only so they do not have physical locations where customers can interact with bank tellers. The cost of running an online-only bank is significantly lower than running a traditional brick-and-mortar bank, Digital banks can pass those savings on to Digital customers by charging fees for conveniences that brick-and-mortar banks do not charge.
11. Trading in Financial Instruments
Digital banks make profits from trading in financial instruments such as bonds, stocks, and derivatives because they have a major advantage over other types of lenders: Digital banks are allowed to use the funds that customers deposited with them for making trades, which means they can generate earnings even though there wasn't any cash received.
For example, Digital Credit Union holds Digital Revolution solutions' money in a Digital Revolutions account that Digital Credit Union uses to buy financial instruments, Digital Credit Union makes profits from buying and selling these financial instruments.
Digital banks can also make money by investing customers' funds in overnight repurchase agreements or short-term investments such as certificates of deposits, U.S. government securities, or Digital Revolution solutions.
Digital banks are exempt from the minimum-reserve requirement that traditional banks have to follow, Digital banks do not have daily deposit limits so Digital customers can deposit all their money into Digital accounts without Digital Credit Union having to follow the reserve requirements of Digital credit unions.
12. Fees and Commissions
Digital Banks make money through fees and commissions charged on products bought through their online platform, providing investment advice, etc. Digital Banks also make money by earning interest on clients' deposits held in Digital Banks' Digital Accounts.
Digital Banks earn interest on these Digital Accounts since Digital Banks are only keeping clients' Digital Funds for short periods of time, just enough to cover the minimum reserves required by law.
13. Offering SME accounts
Digital banks offer Small and Medium-sized business accounts because Digital Banks do not have to spend a lot on upkeep since Digital Banks only exist online. Digital Banks can offer better rates for Loans, Checking Accounts, Savings Accounts, etc. Digital Banks also charge fewer fees than brick-and-mortar banks so they can get more customers to switch from traditional banks.
14. Leverage Digital Banking to Improve Payment Systems
Digital Banks use their Digital Accounts to provide financial services through Digital Payment Systems because Digital Banks do not have to pay for employee wages, benefits, uniforms, retirement packages, health care costs, taxes (income and property), office space rent, or maintenance fees like brick-and-mortar banks.
Digital banks also do not need to spend money on security like brick-and-mortar banks. Digital Banks use Digital Payment Systems because Digital Payment Systems are more efficient than Paper Checks or Cash Transactions, even though Digital Payments Systems do have some fees associated with them.
Digital Banks can improve Digital Payment Systems by encouraging customers to link their Digital Accounts with Digital Payment Systems to Digital Wallets, Digital Cards, Digital Checks, Digital Bills, Digital Loans, Digital Funds Exchangers, Digital Banks to Digital Banks' Channels.
15. Charging overdraft fees
Digital banks are able to charge overdraft fees for Digital Accounts with Digital Cheques, Digital Bills, Digital Checks, Digital Loans, Digital Funds Exchangers because these services are accessible online.
They do not have to make special arrangements with vendors or offices in order to perform these transactions because all of the bank's employees work remotely. For example, Digital banks typically have a policy of allowing an account balance as high as $100 without requiring immediate repayment because the Digital bank uses the Digital customer's next direct deposit to repay Digital banks.
Digital banks typically charge $30 or $35 for overdraft fees that are higher than overdraft protection fees charged by brick-and-mortar banks.
16. Allowing investments in cryptocurrencies
Digital Banks allow their customers to invest in Cryptocurrencies because Digital Banking is not regulated like traditional banking and Digital Banking allows Digital Banks to avoid the costs and overhead associated with traditional brick-and-mortar banks.
Digital Banks can heavily invest in Digital Stock Trading because Digital Stock Market Matchmaking is unregulated. Digital Banks can trade in Digital Currencies that do not have price control or supply control allowed by the Digital Government.
Digital Governments do not regulate Digital Currencies unless they are money laundering, etc., but Digital Bank customers want to trade in Digital Currencies even though Digital Banks have to pay Digital Governments a fee for using Digital Currencies.
17. Charging late fees and interest on loans
Digital Banks can charge their customer's late fees and interest on loans because Digital Banks conduct Digital Transactions through Digital Banking Channels.
Digital Bank Customers do not have to come in physically in order for Digital Banks to process their Digital Transactions. Digital Banks can do all of these transactions from their computers, tablets, or smartphones.
For example, Digital Bank A gives Digital Bank B their Digital File, which contains the Digital Money that Digital Bank A owes Digital Bank B. Digital Bank A does not have to pay any money until they agree on a date of payment because Digital Bank does not charge interest if the borrower pays late.
Digital Banks can also charge interest on loans by requiring borrowers to have Digital Account(s) with Digital Banks in order to receive the loan. Digital Bank B also does not have to pay a lot for office space, employees, or taxes because Digital Bank A is not physically located in any one place.
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