When I first started out in the banking industry, I really struggled to understand what it was all about. I lacked an overview of the banking industry.
The word “banking industry” itself means so many things – customers, products and services, operations, risk management, regulations, etc.
How does one make sense of it all? In my opinion, the best way to get a handle on the banking industry (or any industry, for that matter) is to use a framework.
Call it an occupational hazard of mine, but consultants use frameworks all the time, to structured and categorize knowledge and issues.
So, to help you understand the banking industry better, let’s use a simple framework as shown in Figure 1 below. First up, let’s try to understand the financial services marketplace.
In our example, we start with a simple example of a retail bank. This would be familiar to most of us. It’s the place where you go to place a $3,000 deposit in a savings account so that you can earn some interest, instead of keeping that money in a box under your bed
Retail banks also offer other products and services, such as:
- Current accounts
- Time deposits
- Cheque books and related services
- Credit cards
- Loans, e.g. housing loans, car loans, education loans and overdraft facilities
- Payment and remittance services, e.g. standing instructions to pay for utility bills, or the ability to wire your money to and from overseas bank accounts
- Investments, e.g. mutual funds and stock trading services
- Insurance products, e.g. life, term and personal accident insurance
… and the list goes on.
I won’t go into full detail of these products here – but suffice to say that a retail bank is the most common form of a bank we’re all familiar with and it offers a broad suite of financial related products and services.
Regulatory bodies such as the US Securities & Exchange Commission (SEC) or the Monetary Authority of Singapore (MAS) or the Reserve Bank of India (RBI) are watch dogs that make sure banks don’t run afoul.
Post the Global Financial Crisis (GFC) of 2008, many regulators have slapped punishing compliance and capital requirements on banks, forcing them to reserve high quality assets like cash in their coffers, instead of speculating in bad loans and proprietary trading.
Like I mentioned, a depositor in the context of a retail bank is a standard example we’re all familiar with. We place deposits into savings and current accounts to earn interest. We sometimes place them in time deposits (which earn a slightly higher interest) but lock in your cash for a fixed period of time.
These are the opposite of depositors. A company of individual who needs to finance a project, start a company, buy a property, pay for his or her child’s education would go to a bank to borrow money.
And here’s the thing – banks earn money by charging a “spread’ between deposits and loans. So if they provide you with 1% interest on your $10,000 deposit in a savings account, they make sure they lend that same $10,000 at say 5% interest. In essence, the bank earns the “spread” of 4%, which amounts $400 in our example (quite a chunky amount, as you can see).
It’s important to understand that the financial services marketplace has a set of players called “product manufacturers”. These usually refer to financial institutions which “create” financial products for a bank to sell.
These product manufacturers would usually be specialist providers of financial products – common ones that come to mind are insurance companies manufacturing insurance products, investment banks manufacturing structured products, or fund management companies manufacturing mutual funds and investment portfolios.
Other Third Parties
Of course, you’d realize what I’ve described above is an extremely simplified version of the financial services marketplace. In reality, you’d have many other third parties involved, e.g.
- Credit unions
- Other types of banks, e.g. private banks, investment banks
- Financial Technology providers
If you want to learn more about the banking industry, you should read my Banking Domain Knowledge book.