How Banks Work
Deposits. Loans. Payments. Three words hold the whole trade — and the machinery between them explains every lending decision you will ever meet.
// 01 — THE THREE-WORD BANK
Strip away the towers and the jargon and a commercial bank does three things. It takes deposits — gathering money from people and businesses who want it safe and available. It makes loans — advancing that money to businesses that can use it productively and pay for the privilege. And it moves money — running the payments that let its customers trade with the world. Deposits, loans, payments: the oldest three-word description of the business, and still the truest.
Everything else on this page is the machinery between those three words. The bank's income lives in the gap between the first two. Its intelligence lives in the third. Its constraints — the reason a good business sometimes hears no — live in the capital that must stand behind the middle one. And the reason this page exists on a judgment site is simple: you cannot read a lending decision well, from either side of the table, without knowing what machine produced it. An accountant moving into banking has the numbers cold; what changes everything is understanding why the institution behaves the way it does.
// 02 — DEPOSITS: WHERE THE MONEY COMES FROM
A bank lends money it has mostly borrowed — from depositors first, and from wholesale markets for the rest. The mix matters enormously. Transactional and savings deposits are the cheapest, most loyal funding a bank can hold; wholesale funding is available at scale but reprices with the market and can leave in a hurry. A bank's cost of funds — the blended price of all of it — is the floor under every lending rate it quotes, which is why loan pricing moves when funding markets move, even for borrowers whose risk has not changed.
The structural marvel, and the structural fragility, is maturity transformation: deposits are repayable more or less on demand, while the loans they fund run for years. The bank stands in the middle of that mismatch permanently, managing it with liquid asset buffers and regulatory ratios. Most of what looks like bureaucratic caution in banking is this mismatch being respected.
// 03 — LOANS: WHERE THE MONEY EARNS
The lending book is where the margin is made: the bank earns the difference between its lending rates and its cost of funds — the net interest margin — plus the fees the facilities carry. The number that matters is how thin it is. A bank keeping a few cents a year on each dollar lent cannot afford to lose many whole dollars, and that single fact generates most of what this site teaches: the downside-first reading, the security, the covenants, the monitoring machinery. The desk is not cautious by temperament; it is cautious by arithmetic.
Above the book sits the constraint borrowers meet without seeing: capital. Regulation requires shareholder capital behind every loan, scaled to its risk — and capital is finite, so the bank budgets it: so much appetite for this sector, so much for that name, so much for the year. When a limit is full, the next proposal in that lane meets a no that is not about its credit. Good bankers name that honestly; the products those decisions are expressed in are the product room, and the journey a single request takes through the machine is the next file in this cluster.
// 04 — PAYMENTS: WHERE THE BANK SEES
The third word gets the least attention and explains the most behaviour. Payments — the operating accounts, the transfers, the foreign exchange — earn fees, but their deeper value is twofold. The balances sitting in transactional accounts are the cheapest deposits the bank holds, which links the third word back to the first. And the flow itself is telemetry: the operating account records what actually happened to a business's cash, daily, unedited — the same signal a desk reads in an overdraft's oscillation, months before any set of accounts is prepared.
This is why banks compete so hard for the “main bank” relationship, and why a lender will often price a facility more keenly when the transactional banking comes with it. It is not bundling for its own sake: the bank that runs your payments underwrites you with its eyes open, and the borrower's version of that fact — what your account conduct tells the bank reading you — is worked in How Banks Read You.
// 05 — THE MACHINE, ASSEMBLED
Put the three words back together and the institution's behaviour becomes legible. Pricing reflects funding costs plus risk plus the capital a loan occupies — which is why a committed undrawn limit costs money even when unused. Appetite reflects the capital budget — which is why sectors go “closed” and reopen without any individual borrower changing. Caution reflects the margin's thinness and the depositors standing behind every loan. And the deliberateness that frustrates borrowers — the questions, the documents, the weeks — reflects an institution lending other people's money through a machine designed so that no single judgment, good or bad, can sink it.
For the reader moving into banking from accounting or elsewhere: this machine is the context that turns technical skill into judgment. The question changes at the door — from “are these numbers right?” to “what do these numbers mean for a decision this machine can hold?” — and the career built on that second question is mapped in the career path.
// QUESTIONS PEOPLE ASK
- How do commercial banks make money?
- Mostly from the gap between two interest rates: what the bank pays for money — deposits and wholesale funding — and what it earns lending that money out. That gap is the net interest margin, and it funds nearly everything else the bank does. Around it sit fee income (facility fees, payments, trade finance, foreign exchange) and, subtracted from all of it, the two great costs: running the machine, and the loans that do not come back. Understood this way, every lending behaviour on this site becomes legible — pricing, security, monitoring — because a business earning a few cents on each lent dollar cannot afford to lose many whole ones.
- What is net interest margin?
- The difference between the average rate a bank earns on its lending and the average rate it pays for its funding, expressed against its earning assets. It is the commercial bank's gross margin. Two things follow from its size. First, banking is a thin-margin, high-volume trade — which is why scale, cost discipline and loan losses dominate bank economics. Second, the margin explains the desk's asymmetry: on a normal loan the bank's upside is capped at a few percent a year, while its downside is the whole principal, so commercial credit judgment is downside judgment almost by definition.
- Why do banks care so much about winning a business's everyday banking?
- Because the operating account is all three of the trade's legs at once. It is funding — transactional balances are among the cheapest, stickiest deposits a bank can hold. It is information — the account records what actually happened to cash, daily and unedited, which no set of annual accounts can match. And it is the relationship — the business that runs its payments through you calls you first when it needs to borrow. When a banker seems oddly focused on moving the transactional banking alongside a facility, this is why: the loan is the contract, but the account is the telemetry.
- Why would a bank decline a good business?
- Because a bank can run out of appetite before it runs out of belief. Capital is finite and rationed: every loan must be backed by shareholder capital, and the bank budgets that capital across sectors, geographies and single names. When a sector limit is full, or a single-name exposure is at its ceiling, the next good proposal in that category meets a no that has nothing to do with its credit quality. It is one of the most misread moments in commercial banking — borrowers hear a verdict on their business when they are actually hearing the state of the bank's balance sheet — and a good banker says which one it is.
- Does the bank lend out my deposits?
- In the aggregate, deposits fund lending — that is the trade — but there is no drawer with your name on it being emptied. The bank manages one large pool: deposits and wholesale borrowing on one side, loans and liquid assets on the other, with regulatory buffers of capital and liquidity in between, sized so that depositors can be repaid on demand even though the loans run for years. That maturity transformation — funding long loans with short money — is the genuinely fragile thing at the heart of banking, and most of banking regulation exists to manage exactly it.
// FOLLOW ONE LOAN THROUGH THE MACHINE
The next file in this cluster walks a single facility request through every station of the machine — from the first conversation to drawdown, and why each station exists.
How banks approve business loans →