Fee-based - Financial services, Financial Markets and Institutions | Financial Markets and Institutions - B Com PDF Download

Banks earn their income in two parts. One type of income is generated by undertaking risk i.e. by lending their deposits. This is called interest income and forms the major portion of any bank’s earnings. However, banks can also generate earnings from other sources wherein they do not have to lend money or collect interest. Such sources are called fee based banking services and form an important part of any banks profit and loss statement. In this article we will list down the various sources from which banks can generate non interest i.e. fee based income.

Cards

Credit cards and debit cards have been new addition to the banks portfolios. However, in a short span of time, these services have started accounting for large sums in any bank’s non interest earnings. There are a variety of fees charged by these cards. There are some fees like joining fees and annual fees. Then there are charges such as interest on overdue balance, over limit fees, service taxes etc. All these charges were not a part of any banks earnings a few years earlier. Besides every time a credit or debit card is used, banks that have issued such cards are paid fees by the merchant.

The introduction of credit cards has created this new addition to the bottom line of the bank’s income statement.

Commissions

Banks have also started providing other services like selling insurance and mutual funds to their customers. Since banks have an intimate relationship with the customer, they are in a position to estimate their net worth and advise them regarding insurance as well as investment needs accordingly. Hence, insurance companies and mutual fund companies collaborate with banks to provide a one stop shop to the customers. Banks charge commissions to market these services to their customers. Over a period of time, commissions from bancassurance have started accounting for significant percentages of non interest incomes.

Capital Market Advisory

Banks often assist corporations in their debt issues in the bond market. They understand the macro-economic conditions very well given their vast experience with capital markets. Hence, they can advise corporations regarding the quantum of debt to be issued, the interest rate at which it needs to be issued as well as the time when issuing such debt would make selling it easier.

Banks usually do not underwrite these debt issues. Instead, they simply charge a flat fee for the advise that they provide and the expertise that they bring to the table.

Demand Drafts and Pay Orders

Demand drafts are different from negotiable instruments like cheques. When a bank issues a demand draft, it is no longer the customer’s credibility which is at stake. Unlike cheques, demand drafts are issued by banks and therefore are paid and settled by banks on their own account. The bank is therefore providing a kind of guarantee to the party accepting the demand draft. For all practical purposes, a demand draft can be considered to be as good as cash because it is not subject to realization from the customer’s account. A demand draft will always be paid unless the bank issuing it has gone bankrupt! Therefore banks charge a fee to provide a demand draft. This fees also forms a part of their non interest income.

Guarantees

Banks also provide the service of providing guarantees for a given fee. This service is used to bridge the trust gap between two parties. For instance, party A wants an advance payment whereas party B is willing to pay only after the work is completed. Neither party is willing to trust the other party. In such a case party B can deposit the funds with a bank and the bank can issue a guarantee to party A. Since the bank guarantee becomes a binding commitment made by a credible financial institution, party A can be rest assured that they will be paid once the work is completed as decided. The bank charges a fee for providing such a service. Bank guarantees are often used between first time trade partners. As trade is conducted often, counterparties become comfortable granting credit to each other and the need for bank guarantees is significantly reduced.

Account Related Fees

Banks also charge a wide variety of fees in order to maintain their customer’s accounts. For instance when customers request checkbooks or additional debit cards, they are charged a fee. Besides, banks also charge penalties if the deposits maintained fall below a certain limit. They also charge fees if there are more than a certain number of withdrawals made within a given time period. Some form of payments made via bank accounts also result in fees being charged to the account.

Lockers

Lastly, banks also provide locker services to their customers. This was what the business of banking was originally about and most banks offer this service till date. Customers can store their valuables in the safe vaults of the bank and benefit from the extensive security that the bank has arranged for. The bank cannot access the valuables stored in these vaults and in most cases does not have any information regarding the content of the vaults. The bank merely provides a safe place for storage and charges a fee for the same. Earlier this fee used to form a significant part of non interest income of any bank. However, over time the usage of lockers has reduced drastically and other more profitable fee based businesses have emerged for banks.

Non interest component signify relatively risk free earning for the bank. Therefore banks which have consistently been able to generate stable and high noninterest income are valued highly by stock market investors.