Introduction

The fundamentals of modern banking have not changed over the last 300 years. At a basic level, banks work by paying their customers to lend them money. The bank can then lend money to other people if an individual deposits money into his bank account. The depositing customer gains a small amount of money in return (interest on savings), and the lending customer pays a larger amount of money to the bank in return (interest on loans). The bank retains the difference in order to make money for itself.

Modern day banking can be quite hard to understand, as the business model of banks varies from other industries. For one thing, they are highly leveraged, for they put themselves $20 in debt for every $1 of equity. Also, it can be difficult to understand how banks operate, since they don’t generate any tangible products. And many believe that banking is “free”, probably because banks hold free advertising accounts, free direct deposit and free bill payments, etc.

For example, to fully understand how banks make money, it is important to understand a little about the history of banking. Traditionally, banks made money by borrowing from depositors at low interest rates, lending that money at higher interest rates to borrowers, and pocketing the difference. Banks used to be severely regulated, and a joke among bankers was that it was a 3-6-3 business: borrow money at 3%, lend it at 6%, and close at 3 pm. (That model, better suited to bankers than customers, is long gone.)

Most banks even charged a monthly fee, though most regular transactions are free of charge for customers to retain a basic account. Overall, however, fees are small, reflecting just 30% of total income. Banking is known as the world’s most safe and monotonous career.

The primary source of lending for households, small businesses and farms are the retail banks. While the banking industry accounts of an average of 25 percent of domestic debt,  retail banks account for over 60 per cent of outstanding bank loans to small businesses. For most retail banks, depositors live and work in surrounding areas. Studies have shown that the average savings costs and that financial and other assets are a huge proportion of the profits of a bank. Retail banks deliver a wide variety of banking services that meet the needs of customers and businesses including:- Anytime, anywhere electronic banking,  ATMs- Automated Teller Machines that can be used often with little or no surcharge fees, credit and debit cards with competitive rates and features, home loans, mortgage- and consumer-loan products, competitive current, saving and investment accounts and rates, and  small-business and agricultural lending. 

The banking industry has seen the evolution of a number of long-term and short-term trends that are now converging. Long-term trends include declining industrial margins due to economic cycles, increased competition from fintech, and a range of new regulations. In addition, there has been a significant level of industry consolidation in which inefficient players have either faced closure or merged  with other banks. In terms of channels, there has been a significant shift towards online and mobile channels, with the increasing adoption of new technologies that help facilitate and enhance the experience of multi-channel banking.

In the short term, banks are increasingly trying to maintain their conventional revenue sources while facing new regulatory restrictions on their businesses. As a result, banks are now struggling on a variety of fronts. Not only do they need to increase their overall sales and reduce their operating expenses, but they are also faced with rapidly changing technologies and shifting consumer tastes. All these changes are hampering the bank’s ability to concentrate on end-to-end retail banking. As a result, many banks are considering new ways of doing business that can be transformed into a sustainable business model in the future.

The main functions of a bank are to accept deposits and provide loans. But over time, banks have expanded the range of products and services they offer to their customers. Although, historically, banks have worked mainly through brick and mortar branches and telephone banking, there are now a number of channels, including the internet banking, smartphone apps and ATMs. The increasing number of products has resulted in a high degree of complexity in the back-office and bank processing operations.

There are a multitude of IT systems and applications that the bank has to manage, and a large part of its annual spending goes into upgrading and sustaining these internal IT systems. In addition to in-house processing for a multitude of items, including loans, payments and cards, the ever-growing variety of platforms, such as the internet, web, and devices, has increased the complexity of technology and operations management.

Retail banks are now trying to simplify their business models in terms of products, networks and operations/processing in order to be competitive and profitable. Nowadays, many retail banks are trying to diversify their range of products and services, while not specialising in a particular domain. Such banks are now switching from a complicated end-to-end model to a leaner hybrid or a pure-play model based on digital technology.