In essence, a bank takes short-term deposits and deposits them into long-term loans. Banks pay interest to savers and receive interest on borrowers’ loans. The difference, after deduction, for example, of personnel costs, between the interest paid and the interest received determines whether a bank makes a loss or a profit.
What exactly does a bank do and how does a bank actually work?
Banks ensure that the demand for money and the supply of money in a country come together. For example, some households and businesses have money left over, which they use to save with a bank. Other households and companies are in short supply and therefore need extra money. For this they take out a loan or mortgage. A bank ensures that these money flows come together. They collect the savings from customers and use this, among other things, to provide loans and mortgages.
How does a bank work?
So when you put your savings in a savings account at the bank, you actually give the money on loan. The bank can use it to provide loans and mortgages or to invest. The bank therefore considers savings as a raw material for providing credit and making investments. A bank therefore always needs savings to be able to provide loans. If no or not enough savings are raised, the provision of loans and mortgages will stop.
Assessing the social role and responsibility of a bank is no easy task. A financial institution is by definition a complex organization, and its role in society is not easy to understand for those who do not understand its activities. Therefore a brief introduction to the bank balance sheet.
As with any company, the bank’s balance sheet consists of two sides. On the left or asset side are the assets of the institution. The right side or liability side shows the debts. The annual accounts below show the profit and loss account, which charts profit or loss and shows how it came about.
On the asset side of a bank balance sheet, the attentive reader will find how many loans the institution has issued, which bonds he has in portfolio and how many structured products. The value of the buildings is also listed, as is the goodwill. Simply put, the latter post tries to rate the value of less tangible assets such as reputation, growth potential or brand. The sum of all assets (and also of all liabilities) is called the balance sheet total.
On the liability side, equity is at the top (debts to shareholders). Equity is money that, in principle, is immediately available to a bank.
Interest rate differences due to banking policy
The interest rate differentials between banks are related to this policy. Of course, banks will initially want to attract savings as cheaply as possible, i.e. at the lowest possible interest rate. Only if the interest rate is too low, does the bank run the risk that consumers prefer to deposit their savings with competitors with a high interest rate. The bank then attracts too little savings to finance mortgages and loans.
On the other hand, banks cannot offer too high savings rates either. Because the money they have to pay to attract savings will also have to be recouped. This is usually done by raising mortgage and loan rates. But if the bank raises those interest rates too far, customers will go to the competitor for loans and mortgages. These considerations lead to different rates at all banks.
Under equity is borrowed capital. This includes, for example, the savings (deposits) of the customers, but also the money that a bank borrows from the central banks and on the financial markets to finance its balance sheet. The ratio of equity to the balance sheet total is called leverage. This is the number of times that a bank has placed its own equity in the market.