Understanding The Different Kinds Of Banks And Their Roles

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Late last year, the Financial Stability Board (FSB) published a list of 29 financial institutions which it termed as globally systemically important financial institutions (G-SIFIs). The FSB acts as an overseer of financial activities at the international level and its list named eight U.S., seventeen European, three Japanese and one Chinese banking group. The U.S. banks mentioned were Bank of America (NYSE:BAC), BNY Mellon (NYSE:BK), Citigroup (NYSE:C), JP Morgan Chase (NYSE:JPM), Morgan Stanley (NYSE:MS), Goldman Sachs (NYSE:GS), State Street (NYSE:STT) and Wells Fargo (NYSE:WFC). ((Fitch: U.S. Government Bailout Only Possible For Eight Banks, The Huffington Post, Dec 15 2011))

A look at the list of U.S. banks definitely draws attention to the marked difference among them. While some of these banks have a presence in literally every locality across the country, some of them operate out of  just a handful of offices. Yet all of them are deemed important at the international level.

So what is it that makes these banks essential for the normal functioning of the global economy but so different from each other? We will try to answer this question through a series of articles that will explain the various functions that a particular type of bank performs.

The Types of Banks

All banks primarily have one thing in common – they all deal with money. The difference between them comes from what exactly they do with the money. In its simplest form, a bank accepts deposits and lends out money to customers. Banks that primarily perform this functions are called retail banks and interact the most with individuals through an extensive branch network.

In contrast to these, some banks work primarily with institutions and corporates – helping them raise and manage money. These are the investment banks of the world.

Yet another type of banks are the custody banks which act as custodians of an individual’s or company’s financial assets.

That said, it must be remembered that current banking laws do not restrict a banking group from providing banking services, i.e. retail, investment or custody banking. It is hence not possible to categorize the world’s biggest banking institutions into strict buckets. However, each of these institutions focuses on one aspect of banking more than the others aspects. This is what we fall back on to categorize most of the banks in our discussion. But there are some banks which have such a diversified business model that it would be impossible to put them in a particular category. We hence classify them as highly diversified banking institutions.

  • Highly Diversified Banks: These banking institutions provide the entire spectrum of financial services to their customers. This includes loans & deposits, credit card services, investment banking & advisory services, asset management services and custody banking services. We categorize the country’s three largest banks – JPMorgan, Bank of America and Citigroup – in this group because of their leadership position in almost all the services mentioned above. The chart below shows how much value each of these diversified services adds to JPMorgan.

  • Retail Banks: Wells Fargo and U.S. Bancorp are examples of primarily retail banks, which make a majority of their money from loans. The loan portfolio of these banks includes consumer loans (like auto loans, education loans, etc.), commercial loans (for small and big companies), real-estate loans (commercial real estate loans and mortgages) and even foreign loans.

  • Investment Banks: A majority of the revenue for investment banks comes from trading activities – with the banks buying and selling global debt and equity securities. Another chunk of the revenue comes from advisory and underwriting services. Goldman Sachs and Morgan Stanley are among the world’s biggest investment banks.

  • Custody Banks: The custody banks manage assets for other financial institutions, and earn revenues in terms of fees for managing these assets under their custody and administration. Bank of New York Mellon and State Street act as custodians for assets worth more than $20 trillion each.

We will talk about each of the type of banks defined above in subsequent articles or visit our site for more info on these companies.

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