We all deposit our money in banks. And these banks also give us interest on that money. That is, they give us more money. So have you ever thought about how these banks earn money for themselves? In today’s article.

What Do Banks Do With Your Money?

Think a little: what do banks do with your money? It is not like that the bank took money from you and kept it in a big locker, put two locks and kept the wish with itself, and your money will remain safe in that locker.

This is shown in films. This does not happen in reality. Banks use your money to give loans to others. And the interest rate they charge on that loan is how they earn money. Let us understand with a simplified example. This is a bank. There is only one customer in this bank

How Lending Works: A Simple Example

But what happens is this. So these 100 rupees came to your bank. Now the bank gives this 100 rupees on loan to another person. That other person wants to buy a house. So he has taken a loan for that. This bank charges 8% interest from that other person.

So this 100 rupees of the bank will now go to that other person. Now when that other person returns 108 rupees to the bank, the bank will return 104 rupees to you, and here the profit for the bank is 4 rupees. Basically, this is how it works. But

Risk of Loan Default

Or due to any reason that other person is not able to repay the loan. And you lose your money. Such a situation is very problematic for the bank in the right sense, friend. Obviously, no bank has a depositor and a loan taker. There are a lot of people

RBI Rules and Cash Reserve Ratio

That is why RBI has kept a rule that whatever money the depositors have deposited in a bank, the bank has to keep at least 4% of it in cash reserve. This thing is called the cash reserve ratio. And RBI has to keep a rule for all the banks

Statutory Liquidity Ratio (SLR)

Apart from this, there is another thing called the statutory liquidity ratio. Nowadays this ratio is running at 18%. This is the ratio that RBI is telling the banks that at least this much percent of the deposited money has to be deposited and kept in reserve, where we are starting to say.

There are some things like government bonds or gold reserves, or we have to invest in PSUs. So for Indian banks today, if you forget the 18 plus 4, 22% money, then the rest of the money is from all the deposits. The bank can use it and give loans to them and earn profit for itself by the difference in the interest rate of this loan.

What If Everyone Withdraws At Once?

Now you will ask if this is also not a very big ratio. This means that whatever money we have deposited in the bank, the bank is giving 70-80% of it as a loan to someone else. If I want to withdraw all of it at once. All the debts will be lost.

Because all this money that is deposited with any bank is not kept in cash with it. But realistically this never happens, so this is nothing to be afraid of. Unless people get into panic after hearing some news and money with it

Past Bank Failures in India

This has happened with many banks in the past. First, such a situation happened with PMC Bank. Then such a situation happened with Yes Bank. However, now the situation is under control. And the government also takes steps to bring it under control. In the same way

How Banks Function in Low-Interest Countries

But what will happen in those countries? Where the interest rate that the bank is taking on the loan is very low. Like countries like Germany. Where if you take a housing loan, the interest rate is around 1%. In many cases, the interest is 0.4-0.5%

In such a case, from where will the bank get the difference of interest date to earn? How will the bank earn money? In such cases, friends, which is the situation today in most of the West and European countries, what do the banks do? The savings account interest rate in most countries is 0.1%. In many cases it is absolutely 0%. The bank does not give you any interest for opening a savings account.

And what else happens? Then the bank charges monthly fees. That is, if you want to use the bank, keep your money deposited in the bank, and then you will have to pay monthly to the bank just for doing this. This is not so unrealistic, because in most of the West and European countries, fees are charged for the different services that you start using from the bank.

Some money also comes from there for the bank. However, this is not the main source of income. And the second is the investments that the bank makes. The bank itself is also investing money in different types of banks.

Bank Operating Expenses

And if we talk about expenses, then a bank spends a lot of money. On paying salaries of employees and managers. Up to 30-40% of the expenses. All the expenses can be included here. By the way, you are thinking of saving money for your big goal. You want to buy a new house, you want to buy a new car.

At the same time, you charge 0% brokerage rate. And on your great interface, you can do everything just with a smartphone. You will find the link of your bank in the description below. Do go and check it out. It is free to download. And now let’s come back to the topic. Now let’s take two banks here.

The first is India’s largest bank SBI and the second is India’s largest private bank HDFC. According to the figures of December 2021, the total valuation of HDFC is 8 lakh crores. And the total valuation of SBI is 4 lakh crores. You can see the market share of these banks in this table which shows the market share of the top 5 banks.

Of all the deposits being made in the country, 23.9% of them are deposited in State Bank of India and 8.5% in HDFC Bank. And of all the loans being given in the country, 22.5% of them are given by State Bank of India.

SBI vs HDFC: Market Share Comparison

And HDFC has, by comparison, approximately 6 crore customers. So here even SBI has a higher market share, SBI has more customers than HDFC, HDFC’s valuation is almost 2 times that of SBI. And the reason behind this is that SBI is a government bank.

Public vs Private Sector Banking

And only public sector banks have some social responsibility. They have to invest in some such projects which are good for the country, good for the people of the country. And we have to listen to the government. Whereas private banks, because they are private, have their own choice as to where to invest. This is one of the reasons why the valuation of private banks is so high as compared to public sector banks.

Net Interest Income and Net Interest Margin

Now, I had talked about the profit coming from the interest difference, that how much interest the bank is paying and how much interest the bank is taking, this is called Net Interest Income. What is the difference between the two? Now let us look at the Net Interest Margin of both our examples. If we talk about Financial Year 21, Quarter 3, then for SBI it is 3.34%. And for HDFC it is 4.2%. So you can say that HDFC is slightly more profitable than SBI. Another interesting percentage here which is very important is Gross NPA Percentage.

Non-Performing Assets (NPA)

For SBI this ratio is 4.77%. And for HDFC bank this ratio is 1.32%. So by looking at this you can tell that the situation of HDFC is much better. Although even 4% is not such a bad ratio. If this percentage reaches 7%, 8% or 9%, then it is called bad ratio. Then it can be said that the bank is in trouble that if so many loans become NPAs, they can never be recovered, then it can create problem for the bank.

Profitability Comparison: SBI vs HDFC

And now if we compare the profitability of these two banks, you can see in these tables. Let us first see the table of SBI. How much revenue did the bank earn year after year, how much interest had to be paid and how many expenses did the bank incur. Then comes the financing profit of the bank. Which for SBI is around minus 70,000 crores

which is in positive for SBI. Around 32,000 crores. Tax is paid on that money and then comes a net profit of 22,000 crores. Now we can see the same table for HDFC bank. How much revenue was earned, how much interest, expenses were incurred and the financing profit of HDFC bank is actually in positive. Unlike SBI bank and other income sources are not that much for HDFC bank. So the net profit for HDFC bank is around 31,000 crore rupees. So you can clearly see a difference in the figures of SBI and HDFC.

Final Thoughts and Licensing a Bank in India

But I would say that both are in the same range. This does not mean that HDFC is a better bank than SBI. SBI has its own advantages, Public Sector Bank has its own advantages here. I just showed you the comparisons of both the banks to compare the business model. So do some such work

Because according to some estimates, you should have this much initial capital if you want to open your own private bank in India. You will have to go and get permission from RBI for this because RBI is the boss of every bank here.