At its most basic level, banks make a profit by earning more on loans and investments than they pay on deposits while also generating fee-based income and controlling costs. Bank profitability is the analysis of how well an institution does all of the above.

Relying solely on intuition simply isn’t enough. An increase in competitors vying for your customer’s business, margin compression, and high regulatory costs have all rendered the balance of bank profitability to be more important than ever. Sustainable profitability depends on data-driven analysis at the branch, product, and customer levels.

In this guide, we break down revenue sources, cost drivers, and strategies for finance leaders to measure and optimize profitability.

Core Ways Banks Earn Revenue

Banks rely on several primary revenue streams, each contributing differently to their overall profitability.

• Net Interest Income (Margin): Net interest income (NII) is the difference between what banks earn on loans and investments and what they pay depositors. This is usually the largest driver of margin. For example, if a bank is receiving 6% interest from a borrower and paying 2% interest to a savings account holder, its profit is net-positive.
• Fee-Based and Non-Interest Income: This includes fees like service charges, ATM fees, overdrafts, and various advisory services (like wealth management). For example, many banks charge customers a monthly fee if they do not keep a certain balance amount in their checking account.
• Investment and Trading Income: Sometimes grouped under non-interest income, this includes returns from securities and trading portfolios that fluctuate with market conditions. For example, if a bank invests in a bond, it’ll earn interest. Dividends come from owning shares in other companies, and capital gains occur when a bank buys an asset and then later sells it at a higher price than paid originally.
• Other Income Sources: Loan origination fees, foreign exchange (FX) services, and ancillary offerings help diversify a bank’s earnings. For example, a $500,000 mortgage with a 1% origination fee may generate $5,000 in upfront income, though actual profit depends on the bank’s underwriting, funding, and servicing costs.

Pro Tip: Track interest versus non-interest income separately to see how market changes or customer behavior impact your bank’s bottom line.

Key Cost Drivers That Impact Profitability

Just as revenues drive profits upward, banks must also manage a range of costs that can erode margins if left unchecked.

• Operating Expenses: Personnel, branches, technology, and overhead are recurring costs that vary by bank size and model. While cutting operating expenses (OPEX) can improve margins, reductions must be managed carefully to avoid harming the customer experience.
• Interest Expense: Interest expense is the cost banks pay on deposits and other funding sources. It fluctuates with market rates and depends on the mix of interest-bearing and non-interest-bearing deposits. Banks manage rising interest expenses through pricing strategy, balance sheet adjustments, and interest rate hedging rather than relying solely on deposit size or operating efficiency.
• Credit Losses: All banks anticipate loan defaults and set aside provisions for credit losses. The more accurate the bank’s forecast, the less likely it is to experience substantial losses in a time of high credit losses. However, the number of defaulting customers is greatly impacted by the economy’s performance.
• Compliance Costs: Regulatory and reporting requirements that increase operational expense. This will be higher for some banks than others, depending on geography. These are non-negotiable and fluctuating fees.
• Efficiency Investments: Technology and automation reduce long-term costs and improve service quality. However, they can come with costly start-up costs. If a bank hasn’t reached a return on investment (ROI) for a recent technology integration, it will see profitability impacted.

Pro Tip: Use profitability analysis to identify costs that can be reduced without sacrificing customer experience or long-term growth.

Profitability Metrics Every Bank Should Monitor

Tracking the right metrics gives finance leaders the visibility needed to measure and sustain profitability over time.

• Net Interest Margin (NIM): This is a core metric of bank profitability measurement and analysis. NIM measures the gap between interest earned on loans/securities and interest paid on deposits. A higher margin signals stronger profitability.
• Return on Assets (ROA): Shows how efficiently assets generate profit; a 1% ROA equals $1 profit per $100 of assets.
• Return on Equity (ROE): Measures how effectively a bank turns shareholders’ equity into profit. A higher ROE indicates stronger returns for investors, while a lower ROE can suggest inefficiency or weaker profitability.
• Cost-to-Income Ratio (CIR): CIR shows how well income covers operating costs like wages, rent, and technology. Lower is better, while higher ratios signal inefficiency.
• Fee Income Ratio: This ratio tracks how much revenue comes from non-interest sources like ATM, account, or advisory fees. Strong fee income reduces reliance on interest income and cushions against rate swings.
• Loan Loss Provisions: This measures the share of earnings set aside to cover potential loan defaults, balancing profitability with risk management.

Pro Tip: Move beyond high-level metrics to gain granular visibility into profitability at every level: branch, product, customer, officer, and channel. Understand precisely where your revenue is coming from and where your resources are being deployed.

Strategies to Improve Bank Profitability

Beyond measuring profitability, banks can apply proven strategies to strengthen margins and long-term performance.

• Optimize Pricing and Spread Management: Managing the gap between loan yields and funding costs is central to profitability, but it’s far from simple. Margins depend on rate movements, deposit behavior, competition, and balance sheet structure. Effective spread management requires ongoing analysis of pricing strategy, asset–liability duration, and market conditions to sustain net interest income. 
• Diversify Income Streams: One of the most efficient ways for banks to diversify their income streams is to expand fee-based services to reduce reliance on interest margins. This can include increasing fee incomes that impact the bottom line, like early withdrawal fees and ATM fees. 
• Strengthen Cost Allocation: Assigning expenses like salaries and rent to specific products helps measure true profitability. Understanding these costs gives leaders insight into where to adjust pricing, streamline operations, or shift resources to improve overall performance.
• Enhance Risk Management: Strong risk management supports profitability by minimizing credit losses and preserving capital. By running scenario analyses and stress tests, banks can identify vulnerabilities early and adjust pricing, underwriting, or portfolio mix to protect earnings and maintain stable returns.
• Invest in Efficiency and Technology: Careful investment in technology can encourage automation and reduce administrative costs. This can take the form of a mobile app that allows customers to self-serve or an internal reporting platform that centralizes data.
• Improve Customer Profitability Analysis: Improving customer profitability analysis involves identifying the most high-value customers, so services can be tailored in a way that maximizes lifetime value.

Pro Tip: Profitability solutions can uncover underperforming products or customers, enabling finance leaders to reallocate resources to higher-margin areas.

External and Internal Factors That Influence Profitability

Bank profitability is also shaped by forces outside the institution, as well as internal culture and infrastructure.

• Economic Conditions: Strong risk management supports profitability by minimizing credit losses and preserving capital. Running scenario analyses and stress tests helps banks identify potential vulnerabilities before they impact performance.
• Regulatory Environment: Capital and liquidity requirements constrain how banks deploy capital. Regulation requires modeling, reporting, and optimization, which all carry operational costs.
• Competitive Pressures: Over the last couple of years especially, Fintech and neobanks are attracting customers with low- or no-fee accounts, a satisfactory user experience, and convenience. This puts pressure on traditional banks to retain customers.
• Internal Culture & Data Infrastructure: Strong governance and accurate data are essential to act on profitability insights. Data silos or gaps add convolution that can lead to incorrect assumptions and in turn, plans.

How Finance Leaders Can Optimize Profitability

Finance leaders play a critical role in connecting profitability analysis with strategy, planning, and execution.

• Profitability Solutions: Profitability solutions provide granular visibility into profitability by branch, product, and customer. Ideally, you’ll have a cross-departmental profitability steering committee that includes representatives from finance, IT, and other relevant departments.
• ALM Integration: Data analysis suffers when data is incomplete. Banks that connect these areas gain a clearer view of how funding decisions, pricing, and capital allocation affect overall profitability and enjoy a better view of asset and liability management.
• Budgeting & Planning: Empyrean Solutions’ Budgeting & Planning aligns profitability insights with forward-looking plans to guide strategic decisions. To understand how Empyrean builds iteration into its product, check out our Profitability Rollout in Banking webinar.

Pro Tip: Integrating profitability insights with ALM and planning ensures every decision is supported by consistent, accurate data.

From Earning to Optimizing Profitability

The next time you’re left wondering “how do banks make a profit?” you’ll know it’s a delicate dance between revenue and cost drivers.
However, true profitability goes beyond this balance and focuses on iteration through the form of endless optimizations that make banks run more efficiently and, in turn, more profitably.

As more and more extraneous factors impact profitability, more banks are turning to technological solutions — and less on gut feelings — to help them with profitability management, ALM, and planning.

A profitability analysis solution empowers you to move beyond intuition and embrace the power of data-driven decision-making. It’s an investment in your bank’s future, enabling you to drive sustainable profitability growth, enhance risk management, and gain a competitive edge in the marketplace.