Banking Industry Business Model - Understanding How the Banking System Works

Banking Industry Business Model - Understanding How the Banking System Works

Banks are commercial profitable institutions and need to increase their business, grow their revenue, and provide returns to their owners. Unlike other stores and shops, banks are providing services rather than selling their products. Learn how banks get their funds and how they make money on services. Read more to learn how the banks earn their profit!

Despite their central role in the economy at large and despite the various functions they perform that helps individuals at large, banks are still businesses. For their services, banks need to earn money to keep these institutions going. Banks earn money from various sources but most of their money comes from lending. When banks lend their money they earn loan interest which is paid to them by the borrowers of money. 

Depositors: 

People who put money into banks are called depositors. Banks encourage deposits by protecting the money and by paying the depositor interest, a percentage of revenue earned on the principal over a period of time. The depositor thus earns some money from the deposits. 

Borrowers: 

Using the accumulated funds of many depositors, the bank makes loans to customers it considers likely to repay. When banks lend money, they put it to work. The money that people borrow goes to buy products or services, to manufacture goods, and to start businesses. In this way, the money that banks lend works to keep the economy going. 

The bank charges more interest on the money it lends than it pays depositors, so when the money is repaid; more comes in than going out. 

Interest Spread: 

The difference between what a bank pays in interest and what it receives in interest is the spread or net interest income.  

The spread is not pure profit. The spread is income or revenue, but costs have yet to be considered. 

Banking Costs: 

Costs include maintaining the security of your money, personnel expenses, building maintenance costs, and so forth. 

Profit, or net income, is what's left of revenue after costs are deducted.

Other Income Sources: 

Banks have additional income sources. In addition to loan income, including credit-card interest, they also charge for various services. Charges include fees for rental of safe-deposit boxes, checking account maintenance, online bill payment, and ATM transactions. It is important to note that banks do not earn interest on money kept on hand for services such as ATM transactions. Thus, banks charge fees to offset lost interest. To keep pace with the rising cost of servicing accounts, fees for services have increased significandy. These service fees provide substantial revenues for banks. 

Investments: 

Banks, like people and other corporations, make money on investments. They invest in stock markets and some types of securities and government bonds. While investing their money in instruments other than government bonds, they face the same risks as other investors. They hire professional investment staff to maximize their return on investments. 

Assets and Liabilities: 

  • Why aren't deposits themselves a form of bank income? The money in them doesn't really belong to the bank. You may not like to think of your savings account as a problem for the bank, but it is one in theory. If depositors simultaneously want all their money from all their accounts, banks would be in trouble. 
  • An asset is anything of value. In financial terms, that usually means money. A liquid asset is anything that can readily be exchanged, like cash. 
  • A liability, in financial terms, is a cash obligation. If you borrowed $5 from a friend for lunch, you have a liability of $5 and your friend has an asset of $5. The asset's liquidity depends on how quickly you've agreed to repay the sum and how reliable you are. 
  • For banks, deposits are liabilities. Depositors have the right to request their funds, and the bank must pay them. Money the bank borrowed is also a liability, a debt to be paid. 
  • A bank's assets are its loans and investments, which may be less liquid by contract than deposits. Deposits may have to be returned any time, but assets can arrive in small amounts over a long period. 
  • Because banks have more money out working than they keep on hand, two principles of the banking business come into play. 
  • A bank's liabilities exceed its reserves. The money is loaned out, and the reserves don't match the total of deposits (liabilities). However, the money is out working, financing businesses and expanding the economy. 
  • A bank's liabilities are more liquid than its assets. A bank must give depositors their money if they request it. The bank's assets, however, may be less liquid because they are tied up in longer-term loans, so the bank can't get them as quickly. If many depositors need their money at once, the bank must either break its promise to depositors or pay until its reserves are gone. If the bank fails, unpaid depositors lose their money. 
  • Banking today is not as simple as earning interest on the spread. Rap¬idly changing conditions, complex factors, a 24-hour-a-day global economy, and financial interdependency among nations set the banking climate.




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Creation Date Thursday, 30 May 2013 Hits 15039

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