How Banks Earn Money? | Business Model of Banks | Dhruv Rathee
Banks are often perceived as a money lending entity, but have you ever thought about how do Banks earn money? What is their Business Model? How do they provide you interest over your Deposits? What if all its customers want to withdraw their money at one time? I explain the economics behind how banks earn money and also explain some important concepts such as Cash Reserve Ratio (CRR), Statutory Liquid Ratio (SLR), Bank Run, Non Performing Assets (NPA), etc. in this video.
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00:00Hello, friends.
00:01We all deposit our money in banks.
00:04And these banks give us interest on that money.
00:06That is, they give us more money.
00:08Have you ever thought about how these banks earn money for themselves?
00:11In today's video, let's understand the business model of banks.
00:30Think about it, what do banks do with your money?
00:35It's not like the bank took money from you and kept it in a big locker.
00:39Locked it with two locks and kept the keys with you.
00:42And the money will be safe in that locker.
00:44This is only shown in movies, it doesn't happen in reality.
00:47Banks use your money to give loans to others.
00:51And the interest rate they charge on that loan is how they earn.
00:55Let's understand this with a simplified example.
00:57This is a bank.
00:58There is only one customer in this bank.
01:00And that is you.
01:01You deposit ₹100 in it.
01:03And this bank gives you an interest rate of 4%.
01:06Nowadays, this is the interest rate of 4% in savings accounts.
01:09It is per year.
01:10So this ₹100 comes to your bank.
01:13Now the bank gives this ₹100 to another person on a loan.
01:16That other person has to buy a house.
01:18So for that, he took a loan.
01:20This bank charges an interest rate of 8% from that other person.
01:24So this ₹100 goes to that other person.
01:27Now when that other person gives back ₹108 to the bank,
01:30the bank will give back ₹104 to you.
01:33And here, the profit for the bank is ₹4.
01:35Basically, this is how it works.
01:37But there is a very important question here.
01:39What will happen when the bank has given ₹100 to that other person on a loan,
01:43but the loan date has not yet come back,
01:46but you urgently need to withdraw your ₹100.
01:49The bank does not have ₹100 because it has been given on a loan.
01:52Or for any reason, that other person is unable to repay the loan.
01:56And your money is gone.
01:58Such a situation is very problematic for the bank.
02:02Obviously, no bank has one depositor and one lender.
02:05There are a lot of people.
02:07But still, not all banks deposit their money with them.
02:12Instead, they give it to people on a loan.
02:14That's why the RBI has a rule
02:16that whatever money the depositors have deposited in a bank,
02:19at least 4% of it has to be kept in the cash reserve.
02:24This is called the Cash Reserve Ratio.
02:27And the RBI is the boss of all banks.
02:29The boss decides how much the cash reserve ratio should be.
02:32It changes with time.
02:34Some time ago, it was around 3.5%.
02:36Today, it is 4%.
02:38Another thing is the Statutory Liquidity Ratio.
02:41Today, this ratio is at 18%.
02:43This is the ratio that the RBI is telling the banks
02:46that at least this much money has been deposited,
02:49you will have to deposit it in a reserve.
02:52There are some places like Government Bonds,
02:54or Gold Reserves,
02:56or Securities,
02:58or you have to invest in PSUs.
03:00So for Indian banks today,
03:02if you forget about 18% plus 4%, 22%,
03:04then the remaining money,
03:06from all the deposits,
03:08the bank can use it to give loans to others.
03:11And to earn profit for themselves
03:13from the interest rate difference of this loan.
03:15Now you'll ask if this is not a big ratio.
03:17It means that
03:19whatever money we have deposited in the bank,
03:2170-80% of the bank is giving it to someone else in a loan.
03:24If I want to withdraw all of it at once,
03:26if all the depositors of the bank
03:28want to withdraw all the money at once,
03:30what will happen? The bank will fail.
03:32This is called a Bank Run.
03:34And it will not be possible for any bank in the world.
03:36Because for any bank,
03:38all the money that is deposited
03:40is not kept in cash.
03:42But realistically, this never happens.
03:44So there is nothing to be afraid of.
03:46Unless people panic when they hear the news
03:48and want to withdraw the money together.
03:50Another thing that happens is
03:52that a lot of loans have been given by the bank
03:54and those loans have become bad loans.
03:56And the people who have been given loans are not able to repay them.
03:58And then the bank does not have money left
04:00to pay its depositors.
04:02This has happened with many banks in the past.
04:04First, the PMC Bank had a similar situation.
04:06Then the Yes Bank had a similar situation.
04:08Although now the situation is under control
04:10and the government takes steps to bring it under control.
04:12For this very reason,
04:14a limit is set in such situations
04:16that you cannot withdraw more than Rs 50,000 a month.
04:18This was also the case with the customers of these banks.
04:20But anyway, coming back to our topic,
04:22there is a huge source of income for banks.
04:25The difference in the interest rate.
04:27The interest rate that the bank gives
04:29and the interest rate that the bank takes.
04:31But in those countries where the interest rate
04:33that the bank is taking from the loan
04:35is very low.
04:36Like Germany.
04:38Where if you take a housing loan,
04:40the interest rate is around 1%.
04:42In many cases, the interest rate is 0.4-0.5%.
04:45So this is a negligible interest rate
04:47that the bank is charging for the loan.
04:50In such cases, how can the bank
04:52get a difference in the interest rate for the income?
04:55How can the bank earn money?
04:57In these cases, friends,
04:58which is the current situation in most Western European countries,
05:01what do the banks do?
05:03They reduce the interest on the savings account.
05:07In most countries,
05:09the interest rate on the savings account
05:11is 0.1%.
05:13In many cases, it is 0%.
05:16The bank does not give you any interest
05:18to open the savings account.
05:20And secondly,
05:21the bank starts charging monthly
05:24to open the bank account.
05:26If you want to use the bank,
05:28if you want to deposit your money in the bank,
05:30then you'll have to pay monthly in the bank.
05:33Just to do this.
05:35This is not so unrealistic.
05:36Because this is already happening in most Western European countries.
05:39Apart from this,
05:40there are two other main sources of income for the banks around the world.
05:43First,
05:44the money coming from the fees and commissions.
05:46Different types of fees are charged.
05:48If you're not maintaining a minimum account balance,
05:51then the fees are charged from you.
05:53The fees that are charged for the services that you're using the bank for.
05:57Some money comes from there for the bank.
05:59Although this is not the main source of income.
06:01And secondly, the investments that the bank makes.
06:03The bank starts investing money in different things.
06:06It can invest in government bonds.
06:08It can invest money in gold.
06:10It can invest in the stock market.
06:12The money coming from there for the bank
06:14is also a source of income.
06:16And if we talk about expenses,
06:17a bank spends a lot of money
06:19to pay the salaries of its employees and managers.
06:2130-40% of the expenses
06:23can be spent here.
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06:55Now, let's come back to the topic.
06:57Let's look at some realistic examples
06:59of this business model.
07:01Let's take two banks.
07:02The first is India's largest bank, SBI.
07:04And the second is India's largest private bank, HDFC.
07:07According to the figures of December 2021,
07:09HDFC's total valuation is ₹8 Lakh Crores.
07:12And SBI's total valuation is ₹4 Lakh Crores.
07:15You can see the market share of these banks in this table.
07:18The market share of the top 5 banks is shown here.
07:20All the deposits made in the banks in the country,
07:2323.9% of it is made by the State Bank of India.
07:27And 8.5% is made by HDFC Bank.
07:29And all the loans made in the country,
07:3122.5% of it is made by the State Bank of India.
07:35And 9.6% by HDFC Bank.
07:38As of 31st March 2021,
07:40SBI has a total of 46 crore customers.
07:43And HDFC has, by comparison,
07:46approximately 6 crore customers.
07:48Here, even though SBI has a larger market share,
07:51SBI has many more customers than HDFC.
07:53HDFC's valuation is almost 2 times that of SBI.
07:57And the reason behind this is that SBI is a government bank.
08:00And public sector banks have some social responsibilities.
08:03They have to invest in some projects
08:06that are good for the country and the people of the country.
08:08And often, they have to listen to the government.
08:10Whereas private banks, because they are private,
08:12they have their own choice as to where to invest.
08:14This is the reason why the valuation of private banks is so high
08:18compared to the public sector banks.
08:20Now, the profit that I talked about from the interest difference,
08:23that how much the interest bank is giving and how much the interest bank is taking,
08:26this is called Net Interest Income.
08:28What is the difference between the two?
08:30Now, if you divide this by the total loan,
08:32the total assets with which the bank has earned money,
08:34then you will get the Net Interest Margin.
08:37This is a percentage on which you can judge
08:39how profitable a bank is,
08:41how much profit it is earning.
08:43So, let's see the Net Interest Margin of both the examples.
08:46If we talk about the Financial Year 21 Quarter 3,
08:48then for SBI, this is 3.34%.
08:51And for HDFC, this is 4.2%.
08:54So, you can say that HDFC is a little more profitable than SBI.
08:57Another interesting percentage that is quite important here
09:00is the Gross NPA Percentage.
09:02Out of the total loans that the bank has given,
09:04how many percentages have become bad loans?
09:06That is, there are chances that the loan will never be returned.
09:09For SBI, this ratio is 4.77%.
09:12And for HDFC Bank, this ratio is 1.32%.
09:15So, by looking at this, you can tell that
09:17the situation of HDFC is much better.
09:19Although, even 4% is not such a bad ratio.
09:22If this percentage reaches 7%, 8 or 9%,
09:25then it is called a bad ratio.
09:27Then it can be said that the bank is in danger
09:29that if so many loans have become NPAs
09:32and can never be returned,
09:34then it can be a problem for the bank.
09:35And now, if we compare the profitability of these two banks,
09:38you can see it in these tables.
09:40First, let's look at the SBI table.
09:41Year after year, how much revenue did the bank earn?
09:44How much interest did it have to pay?
09:45And how many expenses did the bank face?
09:47Then comes the Financing Profit of the bank.
09:49For SBI, it is around ₹70,000 crores.
09:53For March 2021.
09:54Remember that all the figures here are in crores.
09:57Then the remaining sources of income are added.
10:00Then the depreciation is seen.
10:01And then comes the Profit Before Tax.
10:03Which is in the positive for SBI.
10:05Around ₹32,000 crores.
10:07The money is taxed.
10:09And then comes the Net Profit of ₹22,000 crores.
10:11Now, we can see the same table for HDFC Bank.
10:14How much revenue did it earn?
10:15How much interest and expenses did it face?
10:17And the Financing Profit of HDFC Bank is actually in the positive.
10:20Unlike SBI Bank,
10:21and the other income sources are not so much for HDFC Bank.
10:24So the Net Profit for HDFC Bank is around ₹31,000 crores.
10:28So you can clearly see a difference in the figures of SBI and HDFC.
10:32But I'd say both are in the same range.
10:34It doesn't mean that HDFC is a better bank than SBI.
10:38SBI has its own benefits.
10:39Public Sector Bank has its own benefits.
10:42I just showed you the comparisons of both banks to compare the business model.
10:46So this is how banking business works in India.
10:49If you want to enter this business,
10:52if you want to open your own bank,
10:54you can do this.
10:55Everyone is allowed to do this.
10:56Because opening a private bank is also a type of business.
11:00Now that you've understood the business model,
11:02you'll need only ₹500 crores.
11:05Because according to some estimates,
11:06you should have this much initial capital
11:09if you want to open a private bank in India.
11:12You'll have to get permission from the RBI for this.
11:15Because the RBI is the boss of every bank here.
11:17So if you have ₹500 crores around you,
11:20you can open a private bank.
11:50If you have ₹500 crores around you, you can open a private bank.
11:51If you have ₹500 crores around you, you can open a private bank.
11:52If you have ₹500 crores around you, you can open a private bank.
11:53If you have ₹500 crores around you, you can open a private bank.
11:54If you have ₹500 crores around you, you can open a private bank.
11:55If you have ₹500 crores around you, you can open a private bank.
11:56If you have ₹500 crores around you, you can open a private bank.
11:57If you have ₹500 crores around you, you can open a private bank.
11:58If you have ₹500 crores around you, you can open a private bank.
11:59If you have ₹500 crores around you, you can open a private bank.