How the Economy Works – How do Banks Raise Capital?
Banks are an important part of the economy. Along with deposits and savings accounts, banks are also involved in lot of other activities to raise money. Like all other businesses banks also need to raise capital. Banks raise capital through various financial investments it provides for different kinds of customers.
Whenever one needs a loan or wishes to deposit money, the first option is to go to a bank. Transferring money from one place to another has become easier through bank accounts. As other business, banks also need to raise capital to sustain. So, how do banks raise capital? Banks provide services and not all the services are free. Banks raise capital by charging a meagre amount for providing different services.
Banks raise capital by providing loans, savings, deposits, credits and other financial techniques. Your money is safe in bank accounts. Instead of doing transactions in cash, you can just let your bank do it for you. One can borrow money from the bank in the form of personal loans, home loans or other loans for business purposes. Banks raise capital by charging interest on these loans. The interest charged by the bank is according to the risk involved. Therefore, if there is more risk involved, banks charge more interest. Interest charged by banks to raise capital also depends on the number of customers who want a particular loan. If there are a large number of customers involved, the bank charges less interest. The interest charged by banks is the main way to raise capital by banks. The bank lends money to its borrowers and charges interest on it.
Are deposit accounts free? Most banks have free deposit accounts; however a minimum balance is required to be kept in the account. If there is less money in the account than the minimum balance, banks raise capital by charging, a service fee to keep the account. Banks also pays interest to its depositors. The interest given to the depositors by the bank is always less than the interest charged by the bank on loans. The difference in the money earned on interest and interest paid to depositors is the capital raised by the banks.
To raise money, banks take a considerable amount of risk. Banks charge interest as per the risk involved. If the risk involved is more, the interest rates rises. Banks can give out a fix amount of loans only; therefore they have to rely on the number of borrowers to calculate interest. If there are a large number of borrowers, the interest percentage becomes low.
Banks raise capital by charging for its services. These services include fee for providing cheques, ATM access, over draft charges and checking. Most of the services provided by banks are paid services. Whether you use an ATM or need a cheque book, you need to pay for it. Some banks provide credit cards. Credits help banks to raise capital as the banks take considerable amount of risk while providing credit cards to customers. Credit cards use money from banks for transactions and customer pay the bank back after the monthly cut off dates for payment. As the bank is providing the money for customer to spend, there is risk involved, such as; if the customer does not pay the bank. Therefore, banks charge a huge amount of interest on credit limits used. Apart for loans and deposits, banks raise capital through investments and securities.
Banks raise capital through investment. Banks raise capital by underwriting that is; acting on behalf of clients as agents to issue securities. This opportunity given by banks to individuals, corporations and governments is called investment banking. Investment banks raise a considerable amount of capital. In investment banking the bank helps the individuals, corporations or government for mergers; it also helps in trading and providing ancillary services. Investment banks are different from other retail banks as they do not take deposits from the customer. Their main work for raising capital is trading securities either in cash or they involve themselves in securities for market making.
Investment Banks raise capital by assisting in foreign exchange, equity securities and also commodities. Banks raise capital by providing traveller’s cheques to people going on holiday. Each bank has a foreign exchange policy. Investment Banks raise capital by dealing in mutual funds, pension’s investments and medical securities for customers. Banks raise capital by charging a fee from the customers for maintaining accounts for trading. Investment banks deal in investment made by customers by investing the capital in stocks and equities.
All banks whether retail, commercial or for investment have various ways to raise capital. As other businesses sell their products to earn profit, banks also sell services and finance deals to raise capital. The difference in capital earned by the banks in form of loans and the interest paid by the bank to depositors is the capital raised by the bank. Banks raise capital by a lot of new and innovative ideas to attract customers. Banks have various loans plans and schemes at different interest rates to attract maximum number of customers. Banks raise capital by taking varied risk in the market. Banks raise capital by giving increased tenure to the customers to pay off loans. As tenure increase risk increases, hence interest earned by the bank increase.
As awareness levels of customers have increased and a number of people wish to invest in mutual funds and securities, the need for agents to help customers have increased. Investment banking plays a major role as agents between customers and the stock market. Investment banks deals with mergers. They earn a profit for mergers and acquisitions. You can get the best pension plans and medical securities, through your investment bank. All you need to do is to pay them a fee for the services.
Banks are also business ventures and like all other businesses, banks raise capital to sustain. Banks raise capital to earn profits. Profitable banks are important for governments as they have lot of customer money involved.