The overall banking business model is simple. Banks receive money from clients which are depositors and the capital markets and lend to other clients which are borrowers, therefore banks make a profit from the interest spread. If a bank borrows money from a depositor at 4 percent and lends it out at 6 percent, the bank has earned a 2 percent spread, which is called net interest income. Furthermore banks also earn money from basic fees, assets under management (AUM) and other services, which is usually referred to as income from fees and commissions or simply noninterest income. If we combine net interest income and noninterest income we end up with the net revenues of a bank or its top line. A further point which is less obvious is that consumers are actually paying for the liquidity services as well.
The center of banking is, due to my experience of working for a bank, one thing: risk management. Banks have to deal with three different types of risk: credit, liquidity also known as “Fristentransformation”, and the interest rate environment. Borrowers and lenders pay banks through interest or fees because they are unwilling to manage the risk on their own, or because banks can do it more cheaply. There are only a few other business in the world where you can take money from people and effectively charge them to take it off their hands. That’s the banking and insurance business model in a nutshell.
But there are many banks, asset managers and insurers out there, most of them in the same country and the same business segment and after all, financial products and services tend to be generic. Despite this fact most of the banks and the finance industry earn some decent returns for themselves and their investors, which is a first sign of a potential moat.