THE BUSINESS OF BANKS

South Africans owe a combined total of R1. 9 trillion in debt to various financial institutions. More than R260 billion of this is attributable to unsecured credit for retail accounts, personal loans, payday loans and credit cards. Interestingly, unsecured loans and credit cards are the fastest-growing type of debt product and almost 80% of credit active South Africans have some form of an unsecured loan. During the COVID-19 lockdown more than 1.6 million South Africans who took advantage of payment holidays offered by financial institutions.

It is estimated that 84% of those who earn more than R15,000 a month have some form of debt (the average middle-income salary is R20,000) and of that, those in bad debt spend 63% of their after-tax income on debt repayments.

The South African government on the other had owes an estimated R3.56-trillion in debt which is equivalent to 62.2 % of the country’s GDP. Add to that the R70 billion and R1 billion loans from the IMF and NDB to assist with COVID-19 relief.

It is clear that we have a deeply embedded relationship with debt as a country. It is therefore important that we not only know what a bank is but how it works and makes money.

A bank is a financial institution that accepts deposits from the general public (for which it pays interest to the depositor) and simultaneously makes loans to the general public (and charges interest on the loan to the debtor) (See: https://propertylink.africa/understanding-the-mechanics-of-the-interest-rate/).

Banks are important in any economy or financial system because they allow for the efficient and coordinated allocation of funds between depositors (savers) and borrowers (debtors). Without this, the general public (including business) would have to individually find people willing to lend money for each specified borrowing event which can become cumbersome and massively chaotic. Banks also provide specialized financial services, which reduce the cost of obtaining information about both savings and borrowing opportunities and the cost of lending. These financial services help to make the overall economy more efficient because of the scale and efficiency made possible by banks and their operations.

Banks (from a retail perspective) typically make money from net interest margin and fees. Net interest margin is the difference between the interest made by a bank on loans made to the general public and the interest paid to customers on their deposits. This is why banks charge a higher interest on their loans compared to the interest paid on deposits. For each loan or investment made and account opened, banks will also charge a fee. These can be called any number of things: administration fees, initiation fees, monthly account fees, service fees etc.  

Banks also make money by selling ancillary products related to their product offering such as insurance.

On the investment banking side it can get a bit more interesting. Investment banks earn fees by advising large companies and public institutions on structured loans, issuing bonds and shares (securities) and underwriting these issues. Investments banks also charge fees for advising companies on mergers and acquisitions and large projects.   

Investment banks also make money by trading securities in the secondary markets and by buying and selling currencies.

In respect of property, it is estimated that South Africans owe financial institutions R939 billion in outstanding mortgage debt.

In relation to your mortgage, the bank will in addition to the interest on the home loan charge an initiation fee, bond registration fee, monthly services fee and an insurance premium with its own initiation fee and monthly admin fee.

With the amount of debt owed by South Africans to financial institutions, it is important that we know and understand how these institutions work, especially with the role they play in the economy.  

*Disclaimer: The contents of this article should not be considered as legal, professional, financial or any other form of advice. These are merely views based on the writer’s personal experience. Readers should obtain independent advice on any matter prior to making any decision.

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