What it means
Strip away the branches and the apps and a bank is an intermediary between people with surplus cash and people who need cash. Depositors want safety and instant access, while borrowers want money committed for years at a time.
The bank stands in the middle absorbing that mismatch, and it is paid for doing so. That middle position is why banks are regulated so heavily.
A bank lends out most of the money it holds, so it can never repay every depositor at once, and confidence is part of the product. Capital rules, liquidity rules and deposit insurance all exist to keep that confidence intact.
For a business, the relationship has three practical strands: transaction banking, credit, and advice. Transaction banking covers current accounts, payment rails, payroll runs and card acceptance, while credit covers overdrafts, term loans, invoice finance and guarantees.
Advice, in the form of introductions and structuring help, is the part most companies underuse. Banks differ by type and it pays to pick the right one.
Retail banks serve consumers and very small firms, commercial banks serve mid-sized companies with dedicated relationship managers, investment banks arrange capital raising and mergers, and central banks sit above the system setting policy rates and acting as lender of last resort. The single most useful measure of a bank's core business is net interest margin, the spread between what it earns on lending and pays on deposits, expressed against its earning assets.
Fee income from payments, cards and advisory work sits alongside it and has become a larger share of profit for many institutions.
In practice
Real-world examples.
Example
A bakery chain banking $18,000 of cash a week moves to a bank with a nearby branch and a lower cash handling tariff, cutting its banking costs and halving the time staff spend on deposits.
Example
An exporter selling into three continents chooses a commercial bank specifically for its trade finance desk, because it needs letters of credit and currency accounts that its previous high-street provider did not offer.
Example
A founder who has been running turnover through a personal account opens a proper business account after her accountant explains that mixed records make the year-end audit expensive and can weaken the protection of limited liability.
Formula
Calculation
Net interest margin = (interest income - interest expense) / average earning assets.
Consider an illustrative small commercial bank. It holds $10,000,000 of customer deposits and pays 2% on them, an interest expense of $10,000,000 x 2% = $200,000 a year. It lends $8,000,000 of that money at an average rate of 6.5%, giving interest income of $8,000,000 x 6.5% = $520,000. Net interest income is $520,000 - $200,000 = $320,000, and the net interest margin is $320,000 / $8,000,000 = 4%. Everything else the bank earns, from account fees to foreign exchange margins, sits on top of that spread.Case study
Seen in the real world.
Rivermouth Tools is an invented company used here for illustration. It had banked with the same institution for eleven years and had never tested the relationship, paying a monthly package fee, a 2.2% margin on its overdraft, and an undisclosed spread on every euro payment to its suppliers.
The new finance manager gathered twelve months of statements and built a simple summary of every charge by category. Armed with that, she approached two other banks and returned to the incumbent with a comparison. The incumbent reduced the package fee, cut the overdraft margin to 1.8% and moved foreign payments onto a transparent rate card.
The fictional example is deliberately unremarkable, because that is the point. Banks price by relationship and by inertia, and a business that measures what it is actually paying usually finds the conversation goes its way.
Watch out
Common mistakes.
- Treating the bank as a utility that cannot be negotiated with. Pricing, margins and fee schedules are all commercial decisions that banks change when asked with evidence.
- Keeping every account and facility with a single institution. Concentration is convenient until the bank restricts access, declines a facility or fails.
- Confusing a bank with a payment provider. Many fintech accounts are not deposit-taking banks and do not carry deposit insurance, which changes the risk profile of the money held there.
Questions
People also ask.
Why does a bank need my accounts before lending?
Because it is pricing the risk that you cannot repay, and management accounts, forecasts and filed statements are the evidence it uses to set the limit and the margin.
What is the difference between a commercial bank and an investment bank?
A commercial bank takes deposits and lends, whereas an investment bank mainly arranges capital raising, trading and mergers for larger clients and does not usually hold retail deposits.
Should a small business have more than one bank?
Two operating accounts at different institutions is a sensible minimum once payroll is material, because it keeps the business running if one provider suffers an outage or a failure.
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