Friday, 4 January 2013

The Business of Banking

Banking is a very essential part of our lives. Where would we be without banks and financial institutions? We cannot even imagine the ease of transactions and the safety of our money without the structure of nationalised banking. Banks and financial institutions have made life easy not only in terms of transactions within the country but also for seamless monetary transactions wherever in the world you are.

When we think of banks we think of them as service providers (which they are) catering to our various financial needs. But, since we aim to become good stock investors, we need to look at banks with a different perspective. Banks too, like other companies are viable business entities and some of them are good stock investment options.
If we are to invest in the banking business as stock investors, it is a good idea to understand them as businesses and how they function. A simplistic idea will suffice. This is our next step in learning to invest in stocks. This time it will be bank stocks and banking sector.

Banks. What are they.....actually ?

In any present day monetary economy like ours, banks form the backbone of the economic structure. They are the source of capital funding for the economy and various industries. If companies were to be set-up and run solely on the basis of individual or collective wealth of the promoters, the world would be a different place. In today’s world, Nobody has 100% equity capital to establish and run a business.

Banks play the vital role of providing funds by means of loans and advances which corporates use to establish and grow their businesses.

How do the banks do it? Where do they
Simple answer....from us, of-course!! Individuals and organisations park their money in banks in the form of various account options, deposits etc. The bank gives interest to the customers at various rates for parking their money with banks. The bank however uses this accumulated funds to lend to borrowers like companies and individuals alike, at higher interest rates. The difference between the interest the bank levies on lending and which the bank gives on its various deposits is the margin which is the source of income to the banks.

This is not all and there is more to banking as a business. We need to learn about at-least some of the basic terms specific to banking. Learning to invest in bank stocks starts with knowing about these terms which are frequently used to compare banks in terms of their business viability. You can read our post on The Fundamental Parameters of Banking for a better understanding of the related terms.