How do banks make money from ISAs?
Banks and ISAs – it’s one of those age old questions – surely the bank is just giving away free money right? Well, kind of but not really. Banks still make a profit from ISAs and in this article we’ll explore exactly they how they do just that.
Why ISAs matter so much in the uk
ISAs are incredibly popular—millions of people in the UK use them as a go-to savings vehicle because of the tax-free benefits. In fact:
- In the 2020–21 tax year, around 11.7 million adult ISA accounts were subscribed.
- People put roughly £75 billion into adult ISAs in that single year.
- The total amount currently held in ISAs across the UK is in the hundreds of billions of pounds.
That’s a massive pot of money. Banks love getting deposits because it gives them a stable source of funds. In return, they pay you interest. But they don’t just sit on that money—instead, they lend it out (for example, via mortgages, personal loans, and business loans) at higher rates, or invest it in other assets, aiming to earn more than they pay you.
The difference between what they earn and what they pay out is their “net interest margin.” It’s how they turn a profit.
OK so what is 'Net Interest Margin'?
Let’s say the Bank of England (BoE) base rate is 4.0%. If you have a fixed-rate ISA paying you 4.5%, it might look like the bank is losing money. After all, 4.5% is higher than 4.0%.
However, the bank may not be borrowing its money at the base rate of 4.0%—it could have access to funds at a lower rate, or be balancing rates across many customers. Plus, they’ll often lend out money to borrowers at an even higher rate, say 6.0% for a mortgage or personal loan. That gap between 6.0% (what they earn from loans) and 4.5% (what they pay you) is 1.5%. Multiply that margin across millions of pounds, and you’ve got a solid source of profit.
Now, if the bank is paying 4.5% on an ISA but lending at only 3.0% somewhere else, that would indeed be a loss. So banks carefully manage their portfolio of loans and other investments to ensure that, on average, they’re earning more than they’re paying out.
So this is part of a banks overall portfolio strategy where they ensure balance across all their products and services, but do they make money on your ISA, specifically? Well, yes…
How banks make money from your ISA
Fixed Rate ISAs
Fixed-rate ISAs typically lock in your interest rate for one, two, three, or even five years. From the bank’s perspective:
- predictable costs: The bank knows exactly what it will pay you over that fixed term, so it can plan its lending or investment strategies accordingly.
- matching with lending: If they’re offering you a three-year ISA at 4.5%, they might simultaneously issue three-year fixed mortgages or loans at 5.5% or 6.0%. That difference (1.0% or more) is part of their profit.
- locking in your deposit: Because you can’t easily withdraw the money without penalties, the bank can use that deposit for stable, longer-term lending. That’s less risky for them than a deposit they might lose at any time.
In essence, a fixed-rate ISA can be seen like a contract: you promise to keep your money with them, and they promise you a set interest rate. Both sides benefit if the terms are right.
Variable Rate ISAs
Variable-rate ISAs are a bit different because the interest you get goes up or down depending on market conditions (and the Bank of England base rate). From the bank’s side:
- flexibility: If the BoE lowers interest rates, they can reduce the rate they pay you. This helps preserve their profit margin.
- short-term sweeteners: Some banks offer an introductory “bonus rate” that’s temporarily high (maybe 4.0% for 12 months), which attracts savers. After that period, the rate might drop to something like 2.5%. Many customers don’t move their money right away, so the bank can pay less interest while still lending at higher rates.
- wide deposit base: Because variable-rate ISAs are easy to open and often promise flexibility for savers (no fixed term, usually fewer penalties), they attract big volumes of deposits. Even if the margin is a bit tighter, the sheer scale of funds can still generate significant profits.
If the bank is lending at 5.0% or 5.5% on average, while paying you an effective average of 3.0–3.5% over time (factoring in any bonus periods and subsequent drops), they keep that 1.5–2.0% margin. It might not sound like much, but on billions of pounds, it adds up quickly.
Why the difference in the “headline” rate vs “true” rate can matter
One thing to watch with variable ISAs is the “headline” or “teaser” rate. Banks might advertise a juicy 4.0% or 4.5%, but that could only last six months or a year. After that, the rate could drop to something more modest.
From the bank’s perspective, this is great—they attract new customers, and later, their margin improves when the rate goes down. For you, the saver, this can be less ideal if you aren’t paying attention and staying ready to switch when that bonus period ends.
What about other banking products?
Banks also make money from:
- current accounts: These often pay little or no interest, but banks might charge for overdrafts or other services.
- regular savings accounts: Similar to variable-rate ISAs, but without the tax-free advantage. Banks may offer promotional rates, then drop them.
- bonds: For example, fixed-rate bonds that pay interest but generally aren’t tax-free like ISAs.
ISAs are special because they’re such a core part of UK savers’ strategies (thanks to the tax advantages). Because so many people want them, banks happily compete in the ISA market, even if margins can be slimmer—there’s just so much money flowing in.
The size and impact on the banking sector
With billions deposited into ISAs each year, this is a massive pool of capital for banks. A healthy ISA market means:
- steady funding: Especially for longer-term fixed-rate ISAs.
- competitive environment: Banks often vie to attract customers with slightly better rates, especially around the tax-year-end (when many people rush to use their ISA allowance).
- economic stability: Large amounts of money stashed in ISAs can act as a stabilising force, making banks less reliant on more volatile short-term funding sources.
What this means for you
Banks make money with ISAs by managing the spread between what they pay you and what they earn elsewhere.
They don’t simply pay out 4.0% or 4.5% and call it a loss; they factor that cost into their overall lending strategy—often lending at 5.0%, 6.0%, or more. This net interest margin, multiplied by billions of pounds worth of deposits, is a cornerstone of banking profitability.
The ISA market is vast—one of the top savings methods in the UK—and that means banks are eager to grab your attention with competitive rates. For you, it’s an opportunity to save tax-free and earn decent returns. Just keep an eye on the details: teaser rates, potential drops, and any penalties if you lock yourself in. That way, you’ll have a better chance of making the most of what banks are offering—while they, of course, make their own profit.
In summary, there are several thing to note:
- banks aren’t losing out
Even if you see a bank offering a 4.5% ISA and compare it to the BoE base rate at 4.0%, remember that banks might lend at 6.0%, or they may have secured funds at even lower rates in the past. The net interest margin is carefully managed. - you can benefit from competition
Because every major bank and building society wants ISA deposits, you can often find decent rates—especially if you look around. If you’re willing to move your money periodically, you can take advantage of bonus rates or better fixed deals. - keep an eye on your rate
Particularly with variable ISAs, the nice 3.5% or 4.0% you start with could quietly drop to 2.0%. If that happens, think about transferring to a better rate (remember to use official ISA transfer processes so you don’t lose your tax-free benefits). - understand the differences
- Fixed-rate ISAs: Good for predictability and often higher rates if you lock away your money, but less flexible if you need quick access.
- Variable-rate ISAs: More flexible, can be good if you believe rates will rise, but can come with lower or declining interest if rates fall.
- use an ISA Calculator
- banks aren’t losing out
An ISA Interest Calculator is a quick and easy way to assess banking offers on ISAs to determine whether they are as good as they say and / or you are getting the return you expecte.
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John is an experienced finance professional having been a financial advisor and city trader for over 15 years he attained his DIPFA in 2013 and has been advising millennial and Gen Z investors and savers on ISAs, investment portfolios and personal savings in the UK.