From the outside, banks can seem intimidating—high in their office towers talking in technical terms and conducting complicated calculations. At its core, though, a bank is a very simple company.
A bank stores money, moves money and lends money.
Banks provide these services to individuals as well as to companies and all types of institutions—even governments. In this article we’ll be describing what most people think of when they hear the word “bank.” These are retail banks, who serve individuals and small and medium-sized businesses, and institutional or corporate banks, who deal with companies, manufacturers, governments, and other commercial entities. We’ll leave investment banks, who serve bigger corporations who need money for large or risky ventures, for the future.
Let’s jump in.
Banks are where we keep our money, and where we most likely receive our paychecks and other money that we earn. And that’s how we save our money: by storing it at a bank. But when money is kept at a bank, not only does it stay safe, it grows as well.
Money deposited in a bank account earns more money called “interest.” A bank calculates the interest it pays as a percentage of the amount deposited. So, 10,000 EGP in an account with an annual interest rate of 3% will grow to 10,300 EGP after one year. While this may not seem much, interest is usually calculated and paid monthly. And since 3% of 10,300 is more than 3% of 10,000, every interest payment no matter how small increases the size of the next payment . . . and the next. As a result, money in a bank can grow surprisingly quickly.
So, where does this interest come from? Well, banks do not just lock your deposits up in a vault; they use the money—chiefly by lending it to others. You can think about interest as the bank paying you “rent” for using your money.
There are many ways to store money at a bank: current, savings accounts, term deposits, certificates of deposit, and more, and the main difference between them all is the time factor and interest.
If you want immediate access to your money at any time a current account is the place to put it. Current accounts come with a debit card, cheques, and other tools so that you can use and get your money easily. You’ll find that a current account is where you do most of your transactions.
But if you can leave your money untouched for a few days or months: a savings account is where you want it. In a savings account, your money earns interest because it will stay there long enough for the bank to lend it to other customers.
Some people might want to leave their money alone even longer. A term deposit, or “TD,” now becomes a good choice. With a TD, you agree not to ask for your money for a specific length of time starting from 1 month up to six months, a year, or more. This promise lets the bank lend the money with more certainty, and in return it pays you more “rent” in the form of a higher interest rate. And if you want to see your savings grow for years and years, the most common solution is a “CD,” a certificate of deposit.
Banks offer many ways to save and invest your money, but they all follow the same principle: the more you promise not to withdraw your money, the more interest you earn.
As we mentioned, a bank doesn’t put your money away in a vault, it puts it to work. As a result, a bank must keep a detailed record of all your deposits, withdrawals, and other transactions. When you write a check, get cash from an ATM, or pay a bill online, the bank adjusts your account accordingly.
These records make it easy for banks to move money. If I want to give you money through a bank, all I have to do is tell the bank, and the bank adjusts our accounts—reducing my balance and increasing yours. You may think this works only if we both keep our money at the same bank, but because of national and international banking standards, it can happen almost as easily between different banks, and even across international borders.
Being able to move money is a wonderfully useful service . . . well, the only way to use money is to give it to someone else. For example, when you buy something with your debit card, the bank transfers money from your debit card account to the store’s. It’s simple for the customer, but inside the bank, the money may move between different types of accounts, and many internal departments to make sure these transactions are recorded properly. There are many examples of moving money, like a family member who is working abroad sending money home, or a company depositing its employees’ salaries into their accounts. None of which could happen without banks.
The main way that banks earn money is by offering loans, and there are many types of loans, but the principle is simple: the bank gives you the amount of the loan in full and you agree to pay it back over time with interest, so that in the end the bank gets back a little more than you borrowed.
Large purchases like buying a home or a new car are often made with a loan. For personal loans like these, you agree to repay the money according to a fixed payment plan. For example: 3,500 EGP every month for two years.
But what if you need to borrow smaller amounts that don’t need a repayment plan? A credit card is perfect. Credit cards offer a convenient and safe way to buy things, letting you pay the bill over a relatively short time, like a month or two.
And for people who don’t want to borrow anything just yet, but foresee that they might, a line of credit or overdraft is the answer. With these, the bank pre-approves you to borrow up to a certain amount, for example, 500,000 EGP. Then you can access the money if you need it. The bank charges interest only on the amount you use, and as long as you pay the monthly interest you can pay back the main amount, called the “principle,” when and how you decide. A line of credit can be good financial security—it’s like having money set aside for an emergency or a sudden need, or even an unexpected opportunity.
A significant portion of the interest that borrowers pay on their loans goes to the customers who have deposited their money at the bank. Remember the “rent” that a bank pays for using your money? Well another way to think about it is the bank sharing the profit that it has earned with your money.
A bank’s main borrowers, though, are companies. Most of us earn money by working, and our only “cost” is our time. But for companies to earn money, they need to buy machinery and raw materials, build factories and rent offices, and of course, hire employees. And unlike your regular salary, a company’s income can vary. For example, a store selling school supplies is likely to have most of its sales in September.
Banks loan money to companies to help them pay the cost of producing their products and to manage the ups and downs of their revenue. A bank can help a company pay its suppliers and keep its business going while it waits for its customers to pay. It can help a company pay for developing and launching a new product or for starting up in a new location. Businesses have a wide variety of financing needs, and banks offer flexible and diverse ways for them to borrow.
But wait a minute . . .?
If you’ve been paying attention, you may have noticed that, on one hand, a bank promises to keep money safe, and on the other hand, it gives it to others. Managing these two sides is the most important aspect of a bank’s business.
Banks are careful about who they loan money to. So, when you apply for a loan, you usually provide information about your income and what property and other valuables you own. You also let the bank check how reliably you pay your bills, like your previous loans or utility bills. You might have to give the bank a guarantee as well. Often this is the right to take something you own, an asset, upon contract between you and the bank and sell it to recover the money if you don’t repay the loan. The asset is called “collateral,” and when you borrow in order to make a purchase, the thing you buy, like a car or house, is usually the collateral for the loan.
Banks are also careful about how much money they lend. They never lend out all their money at once but reserve a fixed percentage to make sure that depositors can safely withdraw money when they need. Economists call this approach to banking “fractional reserve banking,” and it lets banks free up some of the money they hold to be used for helping businesses and expanding the economy.
Because banks are responsible for people’s money and are important to the economy and a country’s financial stability, they are highly regulated. For example, the portion of money that banks must keep in reserve for depositors is set by the national government or the central bank. Other laws require banks to be audited by different authorities and restrict them from making loans that are too risky.
There is one more banking service that we haven’t mentioned: banks provide advice.
Whether you are worried about how to meet your expenses, how to save for a new home or your children’s education, how to start your own business, or how to plan for retirement, a meeting with your bank will help you to understand the options and to make the best choice. It is important for everyone to have a financial guide, and being an advisor whose integrity and advice you can trust is one the most valuable services that a bank can provide.
In fact, trust is at the heart of everything we have talked about. We trust that our bank will have our money when we go to get it. We trust that it will honor the checks we write to pay our bills. We trust that it will lend our money responsibly, and we trust in its ability to make our money grow. So you could say that, at its core, banking is a very simple business—we are in the business of creating trust.