Unit
- Intermediation and maturity transformation: Banks collect deposits from savers and channel those funds to borrowers. This process allows households and businesses to access long-term financing while savers retain the ability to withdraw cash on demand. Banks also operate payment infrastructure that clears checks, settles wire transfers, and processes card transactions.
- Fractional reserve lending: When a bank grants a loan, it credits the borrower's deposit account, creating new money. This credit expansion stimulates economic activity, but it also exposes the bank to liquidity risk if too many depositors withdraw at once, making prudent reserve management essential.
- Central bank safety net: Central banks act as lenders of last resort, supplying emergency liquidity to solvent institutions facing short-term funding gaps. They also set policy interest rates, influence money supply, and regulate systemically important banks, which directly affects how commercial banks price loans and deposits.
- Capital allocation: By evaluating creditworthiness, banks direct capital to productive projects such as infrastructure, business expansion, and housing. Effective screening reduces the cost of capital for firms and raises overall productivity, which is a core reason why banking depth correlates with economic growth.
- Core services bundle: Commercial banks offer a broad set of services: safe deposit boxes, interest-bearing accounts, consumer and business loans, foreign exchange, payment processing, trade finance, and investment products. These services generate fee income and strengthen customer relationships.
- Systemic interconnections: Banks lend to and trade with each other, so the default of one large institution can cascade. The global interbank market links balance sheets, which is why regulators enforce capital and liquidity standards that limit contagion and protect the financial system.
- Revenue drivers: Banks earn net interest income from the spread between lending and deposit rates, plus non-interest income from fees, commissions, and trading. Efficiency is measured by how well the bank controls operating costs relative to its total income.
- Competitive landscape: Fintech firms and neobanks now offer branchless banking, forcing established banks to digitize operations, reduce branch footprints, and invest in automation and analytics to retain customers and control costs.
- Credit and risk management: Banks assess borrower risk through credit scoring, collateral, and covenant structures, then price loans accordingly. Ongoing portfolio monitoring helps identify deteriorating assets before they become nonperforming. Strong risk frameworks allow banks to absorb unexpected losses while continuing to lend through economic cycles, protecting both depositors and shareholders.
- Deposit insurance and consumer protection: Government deposit insurance protects individual savers up to a specific limit, which reduces the risk of bank runs and promotes confidence in the banking system. Consumer protection rules require clear disclosure of interest rates, fees, and loan terms, ensuring that clients understand the cost of credit and can compare products across providers.
Regulatory Requirement
Regulation: Basel III
Banks must hold at least 4.5% of risk-weighted assets as Common Equity Tier 1 capital, plus a conservation buffer of 2.5%, to absorb losses and support financial stability during stress events.
Quick Revision
- Banks intermediate between savers and borrowers and provide payment services.
- Fractional reserve lending creates money but requires careful liquidity and reserve management.
- Central banks supply emergency funds and steer monetary conditions.
- Basel requires minimum capital buffers to limit systemic risk.