The mysteries of banks
Today the banking industry is at the backbone of the economy and it has a major contribution to its growth. Banking is also the main drive for currency and financial stability. But few of us know the story and its functioning well…
How did the story of banking start?
The Term Bank is derived from the Italian word banco which means a bench.
It referred to the public benches where money changers used to sit for exchanging coins or bills in the marketplace. It's the Goldsmith's of the 17th century in London who developed banking in its modern form. The Goldsmith used to store wealthy client's gold in their private vaults and they soon began to lend it to others in exchange for a promissory note and the payment of an interest charge. That was the big game of banking as we know it today.
So what is the general role of a bank?
People with money surplus (depositors) place their money at the bank in order to earn a return through the credit interest.
People with a shortage of money (borrowers) on the other hand are willing to pay interest on the money the bank is lending them in order to accomplish an objective they're seeking.
How do banks make profit?
A bank's primary source of revenue comes from the difference between the interest it's paying to depositors and the one it's earning from borrowers.
Interest paid by borrowers - Interest paid to depositors = Profit made by banks
Additional revenue streams come from charging fees of commissions for services but granted by the bank to its customers and from investments.
Why are banks regulated?
A number of reasons justify why banks need to be regulated.
Banks collect funds from depositors in the form of small size deposits and repackage them into larger sized loans borrowers. Some of the borrowers might not be able to repay the money they've borrowed from the bank.
Additionally, banks sometimes invest deposits in risky assets.
The major role of central banks in protecting depositors money by monitoring the adequate level of riskiness the bank is taking and thus by regulating the banks.
What is the role of central banks?
Central banks oversee monetary policy to implement specific goals such as currency stability, low inflation and full employment. They determine the interest rates that influence the bank's pricing schemes and the economy's money supply. They issue currency and grant authorization to establish banks. Central banks also impose a threshold for capital requirements and place reserve requirements to ensure liquidity in crisis mode. Central banks shape lending policies through margin requirements and other tools and they act as a lender of resort to finance banks that need liquidity.
What different types of banks exist today?
Today, several types of banks exist to answer the different needs of consumers and to give them a choice in the way they manage their money.
- A retail bank for example provides services to individuals.
- Commercial and corporate banks serve small to midsize businesses and large enterprises.
- Investment banks specialize in large and complex financial transactions.
- Private banks offer a personalized financial and banking service to high net worth individuals.