The most important service of a commercial bank is keeping their clients money and lending money out to them. With these services a bank connects clients who have more money than they spend, with those who spend more than they own. This way a bank provides the availability of money for those people who want to start a business or buy a house for instance, but don’t own enough money to do this.
How does a bank make money?
A commercial bank can make money in different ways. The most traditional way is by asking a higher percentage fee – interest – on the money they lend to their clients than the percentage they pay to those clients that deposit their money at the bank for safekeeping.
Apart from asking interest banks also calculate a fixed compensation fee for exercising various types of services or transactions, for example a fixed periodical payment for supplying a system of pay machines and credit cards.
A third way to earn money is giving financial advise. This gives the bank a more stable income as it is less sensitive to fluctuating economic cycli than the difference in interest on loans and deposits.
Some large commercial banks combine their services with supplying insurances. The existing communication between bank and client is also used to sell insurance products.
These are all rather straightforward ways in which banks make their money. With payment services, loans and mortgages they facilitate the development of persons and expanding of businesses. With advise and insurances risks can be covered that otherwise would hamper growth. These are all services with a certain social benefit.
Trading for own account
With money you can make money - this principle is as old as capitalism. And with big amounts of money you can make even more money – all bankers know this. Money lying quietly in a vault is dead money. Markets are constantly in motion. For large banks managing a lot of capital, trading on markets with part of the money can be very profitable and thus tempting. This so called ‘trading for own account’ can make a bank a lot of money in a short time. Because of their large reserves banks can compensate possible losses easier than traders with smaller amounts to work with.
As long as these markets deal in real products, these investment potentially serve a social benefit. Markets are meant to get the optimum price for a product. As the financial sytem developed, more abstract products emerged. Many of these products are not directly linked to, but derived from price developments in the real economy and are therefore called ‘derivates’. The pricing of these products is often based on complicated constructions of which it is not always clear where and with whom the real risks lay. In these markets astronomic profits can be made, so no wonder large banks operate here specially.