Banks primarily make money by earning interest and fees.

The main sources of income are:

• Interest on loans and mortgages

• Fees for services such as payments, accounts, and asset management

• Trading and investment activities (for larger banks)

The core business model is simple:
Banks borrow money at a lower cost (from deposits or markets) and lend it at a higher rate.

The difference between income and costs determines a bank’s profitability.

A bank balance sheet shows what a bank owns and what it owes.

It consists of two main sides:

• Assets: loans, securities, cash

• Liabilities: deposits, borrowed funds, capital

Unlike non-financial companies, banks hold large volumes of financial assets and operate with high leverage.

A strong balance sheet is essential for stability, profitability, and regulatory compliance.

Deposits are funds placed with a bank by customers for safekeeping or transactions.
They represent a liability for the bank.

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Loans are funds provided by the bank to households, businesses, or governments.
They represent an asset for the bank.

 

Banks transform short-term deposits into longer-term loans, a process known as maturity transformation.

Net interest margin (NIM) measures how profitable a bank’s lending activity is.

It is calculated as:

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Interest income minus interest expenses, divided by interest-earning assets.

 

A higher NIM generally indicates stronger profitability, while a lower NIM suggests pressure on earnings.

Interest rate changes have a direct impact on a bank’s net interest margin.

Banks are sensitive to interest rates because:

• Loans and deposits reprice over time

• Funding costs change with market conditions

• Asset values fluctuate when rates move

Rising rates can improve margins but increase credit risk.
Falling rates may support borrowers but reduce profitability.

Managing interest rate risk is a key challenge for banks.

Liquidity refers to a bank’s ability to meet its short-term obligations.

A liquid bank can:

• Pay deposit withdrawals

• Settle payments

• Cover funding needs during stress periods

Liquidity is managed through:

• Cash reserves

• High-quality liquid assets

• Access to central bank funding

Insufficient liquidity can threaten a bank’s survival, even if it is solvent.