How the banking system works
We all, one way or another, interact with banks. Deposits, loans, bank cards, payment of utility bills: this is an integral part of the daily life of every person. But who thought about what are the schemes of banks and how the entire banking system works? Understand how banks make money.
The structure of the banking system in the Russian Federation
In Russia, the banking system is two-tier. The first level is represented by the Central Bank of the Russian Federation, the second – by commercial banks, including Russian branches of foreign banks. The system also includes non-bank credit organizations and banking structures responsible for legislation and infrastructure. In particular, deposit insurance.
The Central Bank performs the function of a regulator and supervisory body, banks are the basis of the financial activity of the system. The profit of the bank as an internal source of its development is the main goal of the activity. Let’s talk about how banks make money.
How banks work
Despite the fact that for most of us, the internal banking “kitchen” is a mystery behind seven seals, their activities come down to just three functions:
In fact, these are the types of bank profits, or rather, their sources.
Bank benefits from deposits
At the initial stage of the formation of the system, banks accepted money from customers for safekeeping and charged commissions for this. Then the idea came that money should work, and not lie idle in safes. This is the main principle of the bank.
How do banks earn on deposits? There are two main ways to manage depositors’ money:
Banks invest in assets: bonds, stocks, mutual funds (mutual funds), carry out operations with precious metals and currencies. This is how the profit of the bank is formed.
The bank scrolls money within its own system, issuing loans to other customers and making a profit on the difference in interest rates between the deposit and the loan.
In fact, during the period when the client holds a deposit in the bank, he becomes its investor. It is beneficial for a financial institution to attract depositors’ money, because this is the main source of the bank’s profit.
Bank benefits from loans
The loan scheme is simple: the client borrows a certain amount of money from the bank and gradually repays the debt, but already a large amount. For banks, this type of activity is very profitable. True, there is a risk that the borrower will not be able to return the money. Therefore, even with a good credit history, banks insure themselves: they take a pledge or require a guarantee from relatives.
It is profitable for banks to lend to businesses; significant amounts appear there. But he is also interested in private borrowers. Interest for individuals is higher; in general, they bring good profits.
Some banks even specialize in lending only to individuals, offering simplified conditions. They earn on the interest rate: the simpler the conditions for obtaining a loan, the higher the rate.
There are also additional services that accompany the transaction. In particular, insurance. Insurance companies pay big money to banks because their risks are minimal.
According to statistics, no more than 1% of insurance owners apply for payment.
What is the benefit of the bank when refinancing a loan
Refinancing is the issuance of a new loan to pay off the previous one. The borrower receives loyal conditions: a lower interest rate, an extension of the debt repayment period and a decrease in the amount of monthly payments.
Of course, in the end he will pay more, but the monthly financial burden will decrease.
When refinancing, money is not issued to the borrower: they are automatically written off to repay the first loan. Also, when refinancing, you can combine 2-3 loans and use the funds received to pay off other debts, for example, credit card debt.
Refinancing can be provided by the one in which the loan was taken, and any other. In the first case, the bank returns its money issued under the previous loan, and in the future increases the profit from the new loan. In the second case, the financial institution gets a new client and also makes a profit. These are the simplified version of the banking scheme.
It should be noted that banks are reluctant to refinance their own loans. For them, the priority is to attract borrowers from competitors: this is how they expand their base of solvent customers.
Installment: what is the benefit of the bank
How much do banks earn on installments? For financial institutions, this is another way to make a profit, though not as profitable as a loan.
The essence of the installment plan is that when buying a product in a store, the buyer immediately receives it and becomes the owner, and then makes fixed payments on a monthly basis. The bank provides the entire amount to the store. At the same time, the buyer does not pay interest to the bank: the store does it for him.
What is it: an attraction of unprecedented generosity? Of course not. This is a way to make a profit for both the store and the bank. It is known that, even after putting aside some thing in the store, not every customer returns to buy it. And with installments, everyone wins: the store is guaranteed to sell its goods and shares part of the profit with the bank.
