"Hello,
friends!" All of us save our money
in banks. And these banks pay us
interest on our savings. They give us
more money. So have you wondered how
these banks earn money? "In today's
blog, let's understand the Business Model of Banks." "Think about it," what do banks do with your money? "It can't be that banks will take your
money," "keep it in a gigantic
locker," "lock it and keep the
keys safely," and the money would
remain in the locker safely. This is the
version shown in films. It's not so in
reality. Banks use your money to give
loans to others. "And the interest
that they charge on that loan," is
their earnings. Let's understand this
with a simplified example. This is a
bank. There's only one customer in this
bank. You. You deposit ₹100 with the bank. And this bank pays you interest at 4%. "Presently, this is the rate of interest
for the Savings Account, 4% per year."
Your ₹100 is now with the bank.
The bank then gives out this ₹100 to some other person. "The other person has to buy a
house," so he took out a loan for
it. The bank charges interest at the
rate of 8% from the borrower. So the
₹100 of the bank went to the other person.
"When the other person pays the bank ₹108," the bank will pay you ₹104. And the bank earns a profit of ₹4. "Basically, this is the way the system
works." "But this begs a very
important question here," "what
will happen when the bank has given ₹100 to the borrower," but the due date to repay the loan hasn't
arrived yet. But you urgently need to
withdraw your ₹100. But the bank doesn't
have the ₹100 with it anymore. Because
it has been given out as a loan. Or the
other person cannot repay the loan for whatever reason. Your money is lost. "These situations are truly very
problematic for the banks, friends."
"Obviously, no bank has only one depositor and one
borrower." There are many people. "Even so, each bank," doesn't keep most of its money with itself. "Instead, it gives out the money as
loans to people." That's why the
RBI has a rule. "Of all the money deposited
by the depositors with a bank," the
bank has to keep at least 4% of it with itself as Cash Reserve. This is known as the Cash Reserve Ratio. And the RBI is the boss of all banks in
India. So the boss decides what should
be the Cash Reserve Ratio. This keeps
changing with time. "Some time ago,
it was around 3.5%" "presently,
it is at 4%." "Apart from it,
there's the Statutory Liquidity Ratio."
This Ratio is at 18% now. This is
the ratio that the RBI directs the banks that
"at least this per cent of the public deposits it has," has to be deposited at a place specified by
the RBI as a Reserve. "Such as in
Government bonds," "or gold
reserves," "or
securities," or investing in PSUs. "So for Indian banks, today, if you forget about the 22% of the money
(18%+4%)," the leftover deposits
with the banks can be used to give loans
to others and earn profits for themselves.
From the difference in the interest rates. You'd say that this isn't a huge ratio. "That of all the money we've deposited
with the banks," the banks are
giving out 70-80% of it as loans to others.
And if you want to withdraw all of it at once. "If all the depositors of the bank want
to withdraw all their money from the bank, " what then?
The bank will fail then. This is
known as the Bank Run. And it is not
possible for any bank in the world. Because
no bank holds all the deposits with itself in cash.
"It doesn't happen realistically, so there's nothing to
be afraid of." Unless people panic
because of some news and everyone wants
to withdraw their money at the same time.
But the thing that does happen is that
"the bank has given out huge loans," and the loans become Bad Loans. And the borrowers cannot repay the money. And the bank is left with no money to pay the
depositors. This has happened to several
banks in the past. "It happened
with the PMC Bank," then the
situation occurred with the Yes Bank. "Although
the situation is under control now,"
And the Government takes steps to keep them under control. "That's why, often in such situations,
there's a limit" "on the
amount of money, you can withdraw in a month," It happened to the customers of this bank as
well. "But anyway, if we return to
our topic," this is a huge source
of income for the banks. The Interest
Rate Difference. "The interest rate
bank pays," and the interest rate
the bank charges. But what about the
countries "where the interest rate
the bank charges from the borrowers,"
is very low. Like countries such
as Germany.
There the interest rate on a housing loan is around 1%. "In several cases, the interest rates
are at 0.4-0.5%." The interest rate
charged on the loans by the bank is almost negligible. "In such cases, how will the bank earn
from the difference in the interest rates?" How will the bank earn money? "In such cases, friends," as with the situation in most of the Western
European countries the banks reduce the
interest rates they pay on Savings Accounts.
"In most of the countries, the interest rate on the Savings
Accounts," is at 0.1% "In many cases, it is at 0%." The bank doesn't give you any interest for
opening Savings Accounts. "And
secondly, the banks charge monthly charges from the people" for maintaining the bank account. "So if you need to use the bank," "if you want to keep the money deposited
with banks," "you'll have to
pay the bank monthly," to do this. It isn't so unrealistic. Because it is already happening in most
Western European countries. "Apart
from this, for all the banks in the world, " there are 2 more main sources of income. "First, the revenue from fees and
commissions." "The various
types of fees being charged," "if
you aren't maintaining a minimum account balance, a fee is charged." The fee that is charged for various services
of the bank you use. The bank gets some
money from there as well. Although it
isn't a main source of income.
And second is the investments made by the bank. The bank invests on its own in multiple
assets. "It can invest in
government bonds," "can invest
in gold," "it can invest in
the stock market," "And the
money that the bank gets from there,"
is also a major source of income.
"If we talk about expenses,"
a major part of the bank expenses is
paying the salaries of the employees and managers. It accounts for about 30%-40% of the total
expenses. Let's look at some realistic
examples of this business model. Let's
take 2 banks. "First is the largest
bank of India, SBI," "And the
second, India's largest private bank, HDFC." "According to the figures from December
2021," the total valuation of HDFC
is about ₹8 trillion. And the total
valuation of SBI is over ₹4 trillion. "You
can see the market share of the banks in this table," it shows the market share of the top five
banks. "Of all the deposits into
banks in the country," 23.9% of the
deposits are to the State Bank of India.
And 8.5% with HDFC Bank. "And
of all the loans given out in the country," 22.5% of the loans are given out by the State
Bank of India. And HDFC gives out 9.6%. "As of 31st March 2021," SBI has a total of about 460 million
customers. "And by comparison, HDFC
has approximately 60 million customers."
"So even though the market share of SBI is more," "and SBI has more customers than
HDFC," HDFC's valuation is nearly
twice than that of SBI's. The reason
behind it is that SBI is a government
bank. And public sector banks have some
social responsibilities.
They need to invest in some projects that "are beneficial for the country and the
citizens," and they often have to
follow government directions. "But
because the private banks are private,"
it is up to them where they want to invest. This is the reason why the valuation of
private banks is so high. As compared to
the public sector banks. "The
profit from the difference in the interest rates that I talked about," "the interest charged by the bank less
the interest paid by the bank," is
known as the Net Interest Income. The
difference between the two. And if you
divide this by the total loans. "The
total assets from where the banks have earned money," you'll arrive at the Net Interest Margin. "This is the percentage on which basis
you can judge," the profitability
of a bank.
How much profit it earns.
So let's see the Net Interest Margin of our examples. "Looking at Quarter 3 of the Financial
Year 21," For SBI it was 3.34% "And for HDFC, it was 4.2%." You can say that HDFC is a bit more
profitable than SBI. Another interesting
percentage that is quite important here is the
Gross NPA percentage. The
percentage of loans given by the bank that have turned into bad loans. That the chances are those loans will never
be repaid. "For SBI, the ratio is
at 4.77%." "And for HDFC bank,
this ratio is at 1.32%." "With
this, you can say that the situation of HDFC is much better." "Although, 4% is not a bad ratio
either." "If this percentage
reaches 7% or 8% or 9%," then it is
said to be worrisome. Then it could be
said that the bank is at risk "if
so many loans have become NPAs," "that
will never be recovered," then it
might be problematic for the bank. "Now,
if we compare the profitability of the two banks," "in these tables, you can see," "let's look at SBI's table first," "the annual revenue of the bank," "the interest that is paid," "and the bank expenses," to arrive at the Financing Profit of the
bank. "for SBI, in March 2021, it
was at -₹700 billion." Remember
that the figures on the chart are in ₹10 million. "Then the other sources of income are
added," "Depreciation is
subtracted then," And thus the
Profit Before Tax is calculated. It is
positive for SBI. Around ₹320 billion. Tax is paid on that figure. And then comes the Net Profit at ₹220 billion.
We can see the same table for HDFC Bank. "The revenue, the interest
expenses," "the Financing
Profit of the HDFC Bank is actually positive," Unlike SBI bank. And the other income sources aren't very high
for the HDFC Bank. So the Net Profit for
the HDFC Bank is around ₹310 billion. "You
can see a clear difference in the figures of SBI and HDFC Bank," But I'd say that both of them are in the same
range. "It doesn't mean that HDFC
is a better bank than SBI," SBI as
a public sector bank has its own set benefits.
I showed the comparison of both banks simply to compare their business
model. "So, friends, this is how
the banking business in India works."
"If you want to enter into this business," "If you want to start a bank," You can do so. Everyone is allowed to do it. "Because after all, starting a private
bank is a form of business." "Since
you've understood the business model,"
you will simply need ₹5 billion. "According
to some estimates," "you need
to have at least this much initial capital," if you want to start your own private bank in
India. You will need to get permission
from RBI for this. Because RBI is the
regulator of the banks. "Check if
you have ₹5 billion lying with you somewhere," you can give it a try too. "And you can comment below to let me
know," "in the next episode of
the Business Model series," which
business model would you like explained? "I've already made blog on Tesla and the
T20 World Cup," explaining their
Business Models. You can click here to
check them out. Let's meet in the next
blog Thank you very much.