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A few weeks ago, we discussed the diversity of funding models among US banks. While the majority of institutions fund their operations using core deposits, others take a more nontraditional approach and rely on brokered deposits. Funding is just one piece of the puzzle though, and the different approaches banks take towards funding reveals the diversity of business models among US depository institutions.
97% of banks earn the majority of their revenue from interest income on loans. However, among those institutions, some specialize in residential mortgages, while others focus on commercial real estate, business lending, or lending to individuals. Non-interest income, which includes fees on bank accounts, servicing fees, and interchange revenue on debit and credit cards (among other things), provides a meaningful amount of revenue to a large number of institutions, with 62% of banks relying on it for more than 10% of their revenue [1].
The diversity of business models comes down to one thing: specialization. Different banks are good at different things. Some banks are good at providing banking services and raising deposits, while others are good at underwriting and asset origination.
Looking at the landscape through the lens of economic theory, specialization is a great thing. Specialization increases productivity and efficiency because it allows institutions to spend their time and energy doing what they do best. However, specialization requires markets and trading. Banks need to be able to work with each other to exchange deposits, loans, securities, and other assets and liabilities in order to make up for any of the activities that they don’t do well. Healthy interbank markets, serving all sorts of assets and liabilities, allow for the beautifully heterogenous banking landscape to thrive.