How do banks make money? The fallacies of fee income
This article documents the dramatic increase in
noninterest income at U.S. banking companies during
the past two decades, the myriad forces that have driven
this increase, and the somewhat surprising implications
of these changes for the financial performance
of commercial banks. We pay special attention to two
fundamental misunderstandings about noninterest income
at commercial banks. The first is the belief that
noninterest income and fee income are more stable
than interest-based income. We review the most recent
evidence from academic studies that strongly suggest—
contrary to the original expectations of many—that
increased reliance on fee-based activities tends to increase
rather than decrease the volatility of banks’
earnings streams. The second misunderstanding is
the belief that banks earn noninterest income chiefly
from nontraditional, nonbanking activities. We perform
some calculations of our own and demonstrate that
payment services—one of the most traditional of all
banking services—remain the single largest source of
noninterest income at most U.S. banking companies.