IMPORTANT FACTS- Types of banks
Retail / high street bank – familiar names like HSBC, Lloyds, Barclays, RBS, NatWest, etc primarily do business with regular consumers, rather than other banks.
Investment bank – they help companies borrow money in the bond market, float shares on the stock market, or buy other companies. They also do their own trades in the financial markets. The biggest ones are JP Morgan, Bank of America Merrill Lynch, Goldman Sachs and Morgan Stanley.
Private bank – a term for banking, investment and other financial services provided by banks to private individuals who have a lot of money/assets. The term “private” refers to the customer service being on a more personal basis than in mass-market retail banking, usually via dedicated bank advisers. One of the most famous is Coutts & Co (the Queen’s bankers), although they are owned by RBS.
IMPORTANT FACTS-How do retail banks make money?
They have two main sources of revenue:
- Net interest– the difference between the interest charged on loans and the interest paid on deposits. For companies who only make loans (e.g. some credit card companies), the income will be the difference between the interest on loans and the interest they pay on money borrowed from other lenders.
- Fees & charges– this ranges from fees to arrange loans and mortgages to bank charges for unauthorised overdrafts, bounced cheques, etc.
See here for a more detailed explanation.
The reserve requirement sets the minimum amount of customer deposits each bank must hold as reserves (rather than lend out). It is normally in the form of cash stored physically in a bank vault or deposits made with a central bank.
The amount of money banks need to have on reserve was increased following the financial crisis and is generally about 7%– see here for more details. The requirements around this are known as the Basel agreements.
Run on the bank
A run on a bank occurs when a large number of bank customers withdraw their deposits because they believe the bank is, or might become, insolvent. As a bank run progresses, it generates its own momentum: as more people withdraw their deposits, the likelihood of default increases, and this encourages further withdrawals. This can destabilise the bank to the point where it faces bankruptcy.
VIDEO- See the infamous run on Northern Rock bank in 2008.
REAL LIFE EXAMPLE: Northern Rock
In 2007 Northern Rock – a retail bank which had a lot of business in mortgages and savings accounts – ran into problems during the credit crunch when it was unable to “sell on” the loans it had taken. It had to go to the Bank of England for cash. This caused customers who had savings with them to panic and many queues were seen in town centres as people tried to get their money out. It was the first time there had been a bank run in the UK for 150 years. In 2008 the bank was taken into state ownership. See here for more details.
IMPORTANT FACTS:How do investment banks make money?
- Fees & charges- investment banks will take a percentage commission of any sales they make. 1% commission when you are selling huge companies turns into a lot of money! If they are managing your money for you they also take a % fee. See here for a fuller explanation.
- Trading- most investment banks also invest their own money in the markets. There are accusations of conflict of interest here and investment banks making money because they have insider knowledge. See here for more information.
TRIVIA: Why do bankers shout across the room?
Traditionally when shares and other financial products were sold on the stock exchange, the traders had to shout and use hand signals to make deals in a method called open outcry. Nowadays, this has almost entirely been replaced by electronic trading. There is just one market in London – the London Metal Exchange – which still uses open outcry. See here for more details.