What is Banking and How do Banks Make Money?

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Banking is the business of safeguarding other people’s money. Banks lend this money, earning interest and profit for both the bank and its consumers.

A bank is a type of financial institution that is permitted to accept deposits and provide loans. However, they may also provide other financial services.

The term “bank” can apply to a variety of financial institutions, such as banks and trust companies, savings and loan associations, credit unions, and any other form of institution that accepts deposits.

How do Banks Make Money?

Diversified banks generate revenue in a variety of ways; nonetheless, at their core, banks are considered lenders. Banks normally make money by borrowing money from depositors and repaying it with interest. Banks will lend the money to borrowers, charging higher interest rates and benefitting from the interest rate spread.

Furthermore, banks typically diversify their business portfolios and create revenue from various financial services such as investment banking and wealth management. However, the money-making business of banks can be divided into the following categories:

  1. Interest earnings
  2. Profits from capital markets
  3. Fee-based earnings

1. Interest earnings

Most commercial banks make the majority of their money through interest income. As previously said, it is performed by withdrawing funds from depositors who do not require them right now. Depositors are provided with a particular interest rate and security for their funds in exchange for depositing their money.

The bank can then lend the deposited monies to borrowers who require the funds right away. Lenders must repay borrowed cash at a higher interest rate than depositors get. The interest rate spread, which is the difference between interest paid and interest received, allows the bank to profit.

Importance of Interest Rates:

Clearly, the interest rate is vital to a bank as a key revenue generator. The interest rate is a proportion of the principal amount owed (the amount borrowed or deposited). In the near term, interest rates are determined by central banks, which manage interest rates in order to foster a healthy economy and limit inflation.

Long-term interest rates are determined by supply and demand pressures. High demand for long-term maturity debt products will drive up prices and decrease interest rates. Low demand for long-term maturity debt instruments, on the other hand, will result in lower prices and higher interest rates.

Banks benefit from giving low interest rates to depositors while charging higher interest rates to lenders. Banks, on the other hand, must manage credit risk, as lenders may fail on loans.

In general, banks gain from an economic climate with rising interest rates. It is because banks can lock in fixed-term deposits that pay a lower interest rate while still profiting by charging lenders a higher interest rate. Intuitively, banks will be harmed by a declining interest rate environment, because fixed-term deposits are locked in at a higher interest rate, while interest rates charged to lenders are down.

2. Profits from capital markets

Banks frequently offer capital market services to firms and investors. The capital markets are simply a marketplace that connects firms in need of finance to fund expansion or projects with investors who have capital but want a return on their investment.

Banks promote capital market activity by providing a variety of services, including:

  • Services for sales and trading
  • Services for underwriting
  • M&A consulting

Banks will assist in the execution of deals using their own in-house brokerage services. Banks will also hire specialised investment banking teams across industries to help with debt and equity underwriting. It simply assists firms or other entities in raising financing and equity. The investment banking teams will also assist with corporate mergers and acquisitions (M&A). Client fees are collected in exchange for the services.

Capital market income is a highly volatile source of revenue for banks. They are entirely dependent on the activity of the capital markets at any particular time, which might fluctuate dramatically. In general, activity will slow during periods of economic recession and increase during moments of economic prosperity.

3. Fee Based Earnings

Non-interest fees are also charged by banks for their services. If a depositor creates a bank account, the bank may charge monthly account fees in order to keep the account open. Banks also impose fees for a variety of other services and products. Here are several examples:

  • Fees for credit cards
  • Accounts for checking
  • Accounts for saving
  • Revenue from mutual funds
  • Fees for investment management
  • Fees for custodianship

Because banks frequently provide wealth management services to their customers, they can benefit from service fees as well as fees for specific investment products such as mutual funds. Banks may provide in-house mutual fund services to guide their customers’ investments.

Fee-based income sources are particularly appealing to banks because they are very steady and do not change over time. It is advantageous, particularly during economic downturns when interest rates are artificially low and capital market activity slows.

Top 5 Banks Of India

1. HDFC Bank Limited (NSE: HDFCBANK)

In terms of market capitalization, HDFC Bank is the largest bank in India.

This private bank’s market capitalisation in 2022 is Rs.617,499 crores.

HDFC Bank Limited (based in Mumbai) operates 5,103 branches and 13,160 ATMs across 2,727 Indian cities. In terms of assets, this bank is also the largest private sector lender in India. HDFC Bank has been crowned India’s Best Digital Bank by AsiaMoney. This banking and financial services firm employs 98,061 people full-time. HDFC’s gross NPA is 1.36 percent.

2. ICICI Bank Limited (NSE: ICICIBANK)

ICICI Bank Limited is an Indian multinational banking corporation with a market capitalisation of Rs. 2,66,974 crore. Its registered office is in Gujarat, and its headquarters are in Mumbai (Maharashtra). In India, ICICI Bank has 4847 branches and 14,987 ATMs. It has offices in 16 countries outside of India, including the United States, China, the Dubai International Finance Center, Singapore, Bahrain, and South Africa, among others. ICICI Bank’s gross NPA is 6.7 percent.

3. Kotak Mahindra Bank Ltd. (NSE: KOTAKBANK)

In terms of market capitalization, Kotak Mahindra Bank is India’s third largest and most private bank. Its market capitalization is Rs. 2,83,464 crores as of 2022. This prominent private bank boasts a nationwide network of 1,500 branches and 2,352 ATMs. Kotak Mahindra Bank was launched in February 2003 and ranked 245th in the Brand Finance Banking 500 by February 2014. It has a revenue of Rs. 31,346 crores and employs over 50,000 people across India. Kotak Mahindra Bank’s gross NPA is 1.9 percent.

4. State Bank of India (SBI) (NSE: SBIN)

The State Bank of India (SBI) is India’s largest public sector bank. This Indian multinational bank is based in Mumbai (Maharashtra) and is placed 221st on the Fortune Global 500 list. SBI is India’s second largest bank by market capitalization. Its market capitalisation is Rs. 2,60,331 crores as of 2022.

In India, there are 22,010 branches and 58,415 ATMs. The gross NPA of State Bank of India is 7.53 percent.

5. Axis Bank Ltd. (NSE: AXISBANK)

Axis Bank is valued at Rs. 1,76,669 crores on the stock exchange. As of 2022, Axis Bank will be India’s 5th largest bank and 4th largest private bank. It has 4094 branches, 11,801 ATMs, and 3,548 cash recyclers across India and is headquartered in Mumbai. Axis Bank Limited has a revenue of 56,044 crores and a workforce of around 78,000 people. Axis Bank’s gross NPA stands at 5.25 percent.


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