What does a bank do better?
How do our banks actually work - banks simply explained
Today we will look together at what a bank is, how a bank works, how it earns its money, how a bank is divided up and what business areas there are. Banks are not the most popular companies and they have received a lot of criticism, especially after the financial crisis.
One hears in the media of high manager bonuses and the rescue of the banks by the state. To understand how banks actually work, we wrote this article.
Small explanation of terms
When one speaks of a bank in Germany, it usually means normal retail banks and not investment banks.
Among the best-known retail and commercial banks are in Germany
- Savings banks
- Deutsche Bank
Apart from the commercial banks, there are also the investment banks. This includes banks like
- Goldman Sachs
- JP Morgan
- Deutsche Bank
If a bank decides to be active in both business areas, then one speaks of a universal bank to which it belongs
- Deutsche Bank
Most investment banks are now following the universal bank approach, as pure investment banking has become too risky and regulated.
How retail banks work
Banks like Volksbank, Sparkasse or Postbank have three main sources of income.
Source of Income 1 - The lending business
Lending business is another term for the lending business where the bank gives credit to its customers.
For example, if the bank gives a personal loan, a real estate loan or any other type of loan, this falls under the lending business.
Source of Income 2 - The deposit business
The deposit business, which is also called deposit business, describes the management of the money, the customers, by the bank.
For example, in sight deposits, in the form of current accounts or overnight money, or in time deposits such as fixed-term deposits.
The interest margin
The bank makes most of the profit with the so-called interest margin. On the one hand, the bank has money that it issues and receives interest in return for lending, i.e. lending.
For example, it gives a corporate loan with 6% interest. But the money also has to come from somewhere.
The lending business is financed by the deposit business, namely customer deposits.
For example, if the interest on the overnight account is 1.5%, then the interest margin for the bank is 4.5%, since the 1.5% is subtracted from the 6% of the loan.
Of these 4.5%, the bank has to pay its running costs, set up risk provisions and what is left in the end is the net profit from interest income.
This interest margin between lending and deposit business is the main source of income for a bank.
Income source 3 - The commission business
Banks also make their money with services that fall under the commission business. The commissions are received by
- Account fees
- Commissions e.g. for Riester contracts
Most of the services provided by a bank are to be found precisely in this service and commission business.
If you want to fly to Turkey and want to have Turkish lira in advance, you can order it from the bank.
Your bank will then deliver the lira to you for a certain commission.
It is the same with your broker who charges 10 € for every purchase or sale of shares.
Such income counts as commission business, as it does not have to be processed on the bank's assets or liabilities side.
The business areas of a retail bank
The business areas listed here are of course not the same for every bank, but differ from bank to bank.
Let's take a look at the typical business areas of a bank, for example.
The private customer business
Banks usually divide their customers into different customer categories, such as A, B and C categories. They do this in order to deliver a better and more adapted standard of advice.
C Customers are often those customers who do not have a high income or a particularly high business relationship with the bank. Usually they have a checking account, a small loan, and perhaps an overnight money account or a savings account.
In this segment, there is no advice on financial investments, if already then possibly via a home loan and savings contract or the Riester pension.
The B customer segment are customers who are already earning a little more money. They sometimes plan to buy a home soon, which gives them a better relationship with the bank than a C customer.
The current account and card business also counts here, and now and then even an overdraft facility or consumer credit.
It is also possible that B client advisors are already involved in real estate financing.
The highest customer category in terms of wealth and income are the so-called A customers. These are mostly managed by private banking or wealth management.
In the private banking sector, bankers are somewhat more experienced or better trained, as they sell, broker and advise on topics such as financial investments.
In order to be considered an A customer, a minimum amount of liquid assets must be available. The limit at which you are considered an A customer differs from bank to bank.
The private banking business is very profitable for the banks, as there are high commissions and large investment sums are moved. The bankers must therefore be well trained, have a good knowledge of the products and always be available for customers.
A segment that only a few banks have, and if so the big banks, is the family office. There a banker looks after one or two very wealthy families he specializes in and gives them all-round advice.
The corporate customer business
Corporate banking is a lucrative and interesting business for the bank. Business with companies is very credit-oriented and the majority of sales are made with loans.
It is interesting because larger loan volumes are taken out and it is not a question of small loans, i.e. not just one but 20 cars.
The freedom to draft contracts also applies, for which the bank can demand additional fees. This is not so easy for private customers.
The asset management
In this area, customer funds are collected by the bank and actively invested in order to obtain the highest possible returns for the customer. Such customers can be private investors as well as institutional investors such as pension funds.
These were roughly the areas that a bank can, but by no means have to. There can also be business areas that have been set up by individual banks themselves.
The bottom line
You should now know that the bank is nothing more than an intermediary, a so-called intermediary. The bank brings together those who have a surplus of money and would like to park the money at the bank with those who currently need money, i.e. who want or need to take out loans.
The bank pays interest on the parked money to those who have excess cash, and the bank charges higher interest than the interest paid to the “lenders” of those who need a loan.
The banks also have a whole range of services for which they receive commissions and commissions. These services can range from simple advice to withdrawing money abroad or changing currencies at the local bank.
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