A bank is a financial institution that accepts deposits from the public and provides credit. Banks accept deposits at a lower interest rate and create credit at a higher interest rate. This difference in the rate of interest is mainly profit for any bank. There are primarily retail, commercial, and investment banks. The central government regularizes banks in most countries for depositor safety like the Reserve bank of India regularizes Indian banks. The bank is generating profit using three methods,
Deposits lending and interest income generation
This is a significant income generation source for any bank. Depositors like saving account holders/fixed deposit account holders have deposited their money into the bank to secure their funds with particular interest on deposited amounts. The bank can lend out these depositor funds to various borrowers in terms of loans at higher interest rates. The borrower/lender has to pay back their loans through equated monthly installment (EMI) or interest to the bank. The bank earns profit through the interest difference between interest paid and interest received.
For example, if the depositor has deposited money in the bank at 4.0% and the bank has landed the same amount to a borrower at 6.5%, that interest difference of 2.5% is the profit margin for the bank.
For the bank’s health, this interesting cycle must be running smoothly and for that banker has to lend money to write a person who will return the taken amount with interest.
Charges on different banking facilities
The bank is also earning non-interest-based income through various charges on services, i.e., Cheque book charges, Return cheque charges, Debit card charges, Account statement charges, Portfolio charges, Processing Fees, or Upfront fees for bank services (loans), Currency exchange charges, safe deposit charges, etc.
Apart from this, nowadays, banks are doing third-party product selling – A wealth management business in which banks earn a commission for wealth management companies on each sale. Bank’s wealth management products are health insurance, general insurance, life insurance, property insurance, mutual fund, etc. Banks are doing tie-up with these service providers and earning commission on selling. In a recent scenario, the bank’s focus is increased on wealth management to earn commission-based income.
Revenue from the Capital market
Banks also provide capital market services to corporate and investors. Banks offer various capital market services to earn fees. Services like –
- Sale and trading services – Banks execute trades with their own in-house brokerage services.
- Underwriting services – Bank has a dedicated investment banking department for the various sector with proper assistance in debt and equity underwriting.
- Merger and Acquisition (M&A) guidance – Bank’s investment banking department guide companies with their Merger and Acquisition (M&A).
Capital market income is a very unreliable source of income as it mainly depends on market economic conditions. Capital market activity increase during economic boosts and slowdown in an economic recession. Hence, banks cannot rely primarily on this income.