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Role Of The Bank In The Economy

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by

Bryan Ong

on 6 August 2014

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Transcript of Role Of The Bank In The Economy

Person A needs a study loan of $5,000. He is not required to pay any installments during the course of his studies.
The bank earns interest from Person A, this is an interest income to the bank.
Let's assume interest rate to be 5%, interest income is $250 per year
Person B needs to purchase new machinery. He approaches the bank to request for a loan of $500,000.
The bank earns interest from Person C, this is an interest income to the bank.
Let's assume interest rate to be 4.25%, interest income is $21,250 per year
5000
Person C wants to become a homeowner. He has $100,000 in his bank and takes a 30 year housing loan of another $300,000.
The bank earns interest from Person C, this is an interest income to the bank.
Let's assume interest rate to be 2.5%, interest income is $7,500 for the first year
500,000
300,000
860
You and I deposit a portion of our income into the bank as savings.
Say everyone places $10,000 into the bank, the bank would collect a total deposit of $100,000 from 10 depositors
The bank pays us interest, this is an interest expense to the bank.
Let's assume interest rate to be 1%, interest expense is $1,000 per year


Other than through retail customers, banks also borrow large sums of money from other banks, in this case, $705,000.
The bank has to pay interest to the other banks at an interest rate known as SIBOR (Singapore Interbank Offered Rate)
This is an interest expense to the borrower bank.
Let's assume interest rate to be 0.5%, interest expense is $3,525 yearly
100,000
The bank, as a middleman, will make a profit from the lending and borrowing activities. Using the values from our examples, Bank ABC's

Interest income from loans = $29,000
Interest expense to depositors = ($1,000)
Interest expense to other banks = ($3,525)
Net interest income = $24,475

The net interest income is used to cover the operating costs of the bank which includes salaries of staff and rental of bank premises.
Retail customers:
So you can see we collected total deposits of $100,000 and we are lending out $5,000 + $300,000 +$500,000. There is a shortage of $705,000. So where does the bank find this money?
As we can see, the bank works as an middleman. The amount that you save in the bank will be lent out to other people to buy cars, houses, etc. It can also be lent to companies to buy machinery, raw materials, etc. Money is circulated this way from "those with" to "those who need"
Role Of The Bank In The Economy:
A Simplified View

Banks are therefore important institutions in any society as they contribute to the development of an economy through circulation of money
Other Banks:
705,000
ABC
Formula for simple interest calculation:
For a sum of $P deposited in a bank at R% simple interest per annum for T years, the simple interest is: I = PRT/100
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