Why big banks get bigger, while small ones disappear

By Jerry Maglunog

Big banks, particularly universal banks (unibanks), have a natural edge over smaller banks when it comes to lending opportunities particularly on big-ticket projects, a Bangko Sentral ng Pilipinas (BSP) official said.

“A bank’s main source of revenue is its lending operations. Although banks charge interest, it allows businesses to grow from loans it provides,” BSP Dep­uty Governor for Supervi­sion and Examination Sector Nestor Espenilla Jr. said.

He said banks special­izing in commercial loans usually rake in more income than those that concentrate only on consumer loans or micro loans offered mostly by rural banks.

Specifically, banks collect interest on loans and interest payments from the debt securities they own, and pay interest on deposits and short-term borrowings.

The difference is known as the “spread,” or the net interest income, and when that net interest income is divided by the bank’s earn­ing assets, it is known as the net interest margin.

The largest source, by far, of funds for banks is de­posits—money that account holders entrust to the bank for safekeeping and use in future transactions, as well as modest amounts of interest.Generally referred to as “core deposits,” these are typically checking and sav­ings accounts.

Outside of lending, the BSP official said, big banks can also generate revenues from proprietary trading, foreign-exchange (forex) op­erations, investments, credit card, and fees.

In most cases, fees and proprietary trading are the banks’ second and third largest sources of revenues.Proprietary traders may use a variety of strategies, such as index arbitrage, statistical arbitrage, merger arbitrage, and fundamental analysis.

Fees are charged for all bank services provided to clients, such as non-suffi­cient funds fees, overdraft charges, late fees, over-the-limit fees, wire transfer fees, monthly service charges, account research fees and more. Espenilla said the in­come from the forex usually lies with the treasurer.

“If the treasurer is aggressive, revenues from forex will be substantial,” the deputy governor said.

The forex market works through financial institu­tions, and it operates on several levels.

Behind the scenes, banks turn to a smaller number of financial firms known as “dealers,” which are actively involved in large quantities of forex trading.

Most foreign exchange dealers are banks, so this behind-the-scenes market is sometimes called the “in­terbank market,” although a few insurance companies and other kinds of financial firms are involved.

Trades between forex dealers can be very large, involving hundreds of mil­lions of dollars. Because of the sovereignty issue when involving two currencies, the forex has little (if any) supervisory entity regulating its actions.

The remaining two rev­enue sources, investments and credit cards, are not perennial sources of good revenues because they rely on market forces.