Banks: their roles, loans and interest

Your earnings from your holiday job are in your youth bank account. But are they really sitting there – like a bicycle in the cellar? No: the bank puts this money to work. In “Der erweiterte Wirtschaftskreislauf: Staat, Banken, Ausland”, you learnt about banks as participants in the circular flow of the economy – and you were promised that you would look at how banks earn money and what a loan costs ‘later, in the module on banks’. This is where you are now.

Banks have three core functions:

1. Accepting deposits: They collect savers' money – your earnings from your holiday job, your grandparents' savings, the club's money from its festival. This money is called a deposit.
2. Granting loans: They lend the money they have collected to those who currently need more than they have – a bakery for a new oven, a family for a house, a company for machinery. The money borrowed is called a loan.
3. Processing payments: They move deposit money from one account to another – your wages come in, your mobile phone bill goes out, and your card payment in a shop is debited from your account. Without this third function, you would hardly be able to pay for anything today.

The bank is therefore a hub: savings flow in on one side and loans flow out on the other. This connects people who have money to spare with people who need money – and your savings may indirectly be in your bakery's oven.

Why do savers bring their money to the bank in the first place – and why does the bank not lend it out for free? The answer is interest. It has two sides, depending on which side you are on:

• For savers, interest is a reward: Anyone who lets the bank use their money receives a small percentage credited to their account each year – savings interest.
• For borrowers, interest is a price: Anyone who borrows money pays a percentage each year – loan interest. Borrowing money costs something, just like renting a flat.

Let's work through this – with simple annual interest on CHF 1000:

• You put CHF 1000 into a savings account at 1 % savings interest: after one year, you receive 1 % of 1000 = CHF 10 in interest.
• The bakery borrows CHF 1000 at 4 % loan interest: it pays the bank 4 % of 1000 = CHF 40 in interest per year.

The formula behind this is simple: Interest = amount × interest rate. (The interest rates here are examples – actual rates change all the time.)

Now you can see the bank's business model: it pays savers 1 % and charges borrowers 4 %. The interest rate spread of 3 percentage points stays with the bank – it uses this to pay for staff, branches and computers, and what is left is its profit. Loan interest is also higher because the bank takes a risk: not every loan is repaid in full.

The bank does not lend its own money – it mainly lends the money that savers have entrusted to it. That includes your earnings from your holiday job. This is why it cannot afford to be careless: before granting a loan, it checks creditworthiness (also called credit standing) – the question is: Can and will this person or company repay the money plus interest?

To do this, the bank looks at things such as:

• income: are wages or business profits enough to cover the instalments?
• existing debts: someone who already has lots of loans carries a higher risk.
• past payment behaviour: have previous bills and loans been paid reliably?
• for companies: the business plan – is the new oven actually worth buying?

If the assessment is poor, there are consequences: the bank rejects the loan application – or charges higher interest because it is taking a greater risk. This may seem strict, but it protects both sides: savers from losing their money, and borrowers from taking on debts they cannot afford. You will look at what happens when debts still get out of hand in “Persönliche Finanzen II: Schuldenfallen und digitales Bezahlen”.

For Liechtenstein, banks are much more than useful service providers – they are a key industry. A few figures give you an idea of the scale:

• Liechtenstein has 11 banks – a remarkably large number for a country with just over 40 000 inhabitants.
• The financial sector (banks, insurance companies and trust services) generates just over a fifth of the country's total economic output – only industry contributes more.
• Liechtenstein's banks manage client assets of over 500 billion francs – many times what the small country itself produces. Many customers come from abroad.

Why Liechtenstein in particular? Reasons include the stable currency (the Swiss franc from “Money: Functions and History”), political stability, membership of the European Economic Area (EEA) – and a great deal of trust built up over time: when it comes to money, reliability matters more than anything else.

For you, this has a very practical meaning: the financial sector offers many jobs and apprenticeships – for example, a commercial apprenticeship at a bank. You do not need detailed knowledge of banking products yet; what matters is the overall picture: banks are to Liechtenstein what a large factory is to other regions – a pillar of the economy.