Banks and Money

Basic Functions of Banking
The basic functions of banking are:

  • The collection of funds from the public.
  • The safeguarding of those funds.
  • The transfer of those funds from one person to another without their leaving the bank (this is done by means of cheques or automatic transfer through the banking system, or via the Internet etc)
  • The lending of that money to other parties for a return or reward called interest.

Loans made by a bank are based on the amount of funds held by the bank at any time, after taking into account sums that must be held in reserve in case the owners of the funds require them from time to time.

The loans are, of course, made with proper security in place in case there is default. The interest received is shared between the bank (i.e. their income for managing those funds) and the true owner. (The true owner’s reward is a share of the interest, which is paid to him/her for not using his/her money.)

A bank is therefore an institution that deals in money, as well as providing other financial services. They accept deposits of money from customers and they make loans of those funds to generate a profit. This profit is the difference between the interest they receive from the borrowers and the interest they pay to the customers who own the funds.

Banks are essential to any country’s economy as well as the world economy. The function of banks is to administer the funds given to their care and using it to make a profit.

What actually happens?
When your money is deposited with the bank, it is transferred into a big pool, along with everyone else’s, and it is from this pool that money is lent out to generate income by way of interest. If you write out a check or make a withdrawal, the amount taken is deducted from the balance of your account standing with your bank. If you leave your funds there and allow the bank to lend them out, then the interest portion that belongs to you is credited to your account by your bank.

Banks, in fact, create money by making loans to other parties. The amount of money banks are able to lend is controlled by the Federal Reserve Bank. This control takes the form of requiring the banks to hold a percentage of their funds in reserve and to lend out only the balance.

How do Banks Make Money?
Banks make money by lending your money out at interest and by charging you for services provided. When they lend your money they have to balance their objectives of creating as much income as possible for themselves, with their obligation to play it safe and maintain security for that money. They also have to maintain a good liquidity position in case you and all other customers want to draw cash out.

Liquidity and profitability are sometimes opposite positions - one cannot generally have both at once. If you are able to lend your money for long periods then a lot of interest can be earned. However the bank cannot lend so much of that money out that they prevent their customers from having access to their cash when they want it.

Banks therefore run the operation like a businesses because, in fact, that’s what they are - a business. Your business’s product may be a piece of equipment or machinery or clothing or food. The bank’s product is cash, or money. They sell this money in the form of loans and other financial type products. They make their money on the interest and fees they charge on these loans and they pay others for that money. These others are their customers.

The key is, banks must get more interest income coming in from loans given out, than the cost of interest they pay have to pay out (to customers for allowing their funds to be deposited with them).

The other big revenue items generated by banks are the fees they charge. The old days where only a small portion of the bank’s income came from fees charged has long gone.

Today, bank fees make up a substantial bulk of the bank’s earnings and they charge for every service, whether it is for an electronic transaction, or honouring a withdrawal from an ATM machine, or permitting a transfer through the Internet banking system. Bank’s fees add up to multi millions worth of income for the bank but are a constant source of aggravation and annoyance to customers.

Another large source of income for the bank is returns from investment and securities. Here the banks take some of the funds they hold and purchase other products, such a shares or equity in businesses. This in turn generates profits, which is received by the bank by way of dividends etc.ank notes will soon become obsolete. When this happens, the change in the nature of money will have a significant effect on our society.

StartRunGrow (http://www.startrungrow.com) is a global online information organization that specializes in creating, developing and marketing business help information specifically with the aim of “making business easier” for entrepreneurs around the world. The StartRunGrow objective is to become a dominant player in the business help arena providing end to end solutions for the millions of small and medium businesses worldwide who continue to struggle daily with the difficulties of starting, running and growing a successful business.

This entry was posted on Tuesday, December 26th, 2006 and is filed under Money Management. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.
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How Credit Scores Affect Mortgage Applications

With a good credit score an applicant will receive prompt response from many lenders, all of them offering low interest rates and low down payment options. The loan amount offered also may be high. On the contrary a low credit score would result in a lot of rejection from various mortgage financers. Because creditors wouldn’t come forward easily to give credit to individuals that have a history of difficulty in repaying existing loans. After all, creditors take risk when they finance mortgages against the credit history of a debtor. Naturally, they will wish to remain on the safe side and pick up less risky ones that have good credit histories. A good credit score means less chance of missing on payments and therefore less risky.

But there are some real risk takers that will come forward to finance mortgages for individuals with bad credit scores. They would charge high down payments and always high interest rates though. They may also fix additional charges for every little paper work and may charge high closing rates. The loan amount offered will also be considerably less. The individual with poor credit scores will not have much choice but to accept the terms and conditions as there are no other alternatives. This is a tight situation and to avoid this you must have a good credit score.

People with bad credit may fall in to the trap of ’secured loans’. Secured loans are the ones where the loan applicant offers an asset as collateral security. The lender becomes secure about the repayment of the loan and not the borrower. Securing a loan with bad credit score becomes easy only when the applicant is willing to offer some asset as collateral security. This again is a very dangerous situation where an individual runs the risk of losing his entire collateral asset in case of failing to pay the loan installments in time. An individual should always avoid such type of a loan.

Resort properties normally require large amounts of finance which a person with bad credit may find it difficult to obtain. So it is always advisable to keep your credit score high. Incase the credit score becomes low due to unavoidable financial reasons it can be improved upon. There is no need to lose hope simply because a person has a low credit score. If the property that he intends to buy has good equity he should go out and try to obtain finances for it. There are many sub prime lenders willing to offer their services.

For a review of your credit report as it relates to a mortgage loan and a consultation on the best loans available to you, give us a confidential, no obligation and no cost call.