As core institutions of the financial system, banks' profit models have always been a hot topic for entrepreneurs. Banks' operations can be categorized as on-balance sheets and off-balance sheets. The essence of the on-balance sheet model is to raise funds from unspecified sources at a fixed cost and then invest them in assets such as loans and bonds to generate higher returns.
The banking model is actually very simple: it takes money from some entities, invests it in other entities in some way, and then profits from the corresponding interest rate spread. There are two methods of raising funds: equity and debt. We won't discuss equity in detail. Raising funds through debt is called liability business, while investing the funds in other economic entities through loans and other means after raising funds is called asset business.
Bank liabilities can be categorized as active and passive liabilities. Passive liabilities are primarily deposits, while active liabilities are liabilities that the bank can adjust independently, including interbank lending, interbank deposits, and bond issuance.
A bank's asset-based operations can be divided into lending and financial market operations. Lending includes personal loans, corporate loans, and bill discounting (since bill discounting is included in credit statistics, it is included in this category). Financial market operations primarily focus on investment and financing in the financial markets, primarily including bond investment, interbank investment, and interbank financing.
In addition, banks also develop intermediary businesses based on their asset-liability operations. These businesses are neither assets nor liabilities and are kept off-balance sheets. We are familiar with wealth management and fund distribution businesses, which fall into this category.
A bank's net profit = operating income - provisions - operating expenses - income tax.
Assets generate income, and liabilities have costs. Therefore, from an asset-liability perspective, a bank's income is simply asset income minus liability costs, which is called net interest income. However, since banks also engage in intermediary business, the income generated from this is called non-interest income.
Therefore, the formula:
Operating income = non-interest income + net interest income. Net interest income is the bulk of a bank's revenue.
Net interest income = Interest income - Interest expense = Net interest margin * Size of interest-earning assets
Net interest margin reflects a bank's core competitiveness in its core business and is one of the most critical indicators of bank profitability. The net interest margin is a function of interest income and interest expense. Interest income represents the return on assets, while interest expense represents the cost of financing. Therefore, interest income depends on the structure and yield of interest-earning assets, including loans, securities investments, deposits with the central bank, and interbank assets. Interest expense, on the other hand, depends on the structure and funding costs of liabilities, including deposits, issued bonds, and interbank liabilities.