Why Banks Matter but They Don’t Actually Create Much for the Economy on their Own
I still remember the first time I opened a bank account. It was a joint account with my parents. For those who still remember the 2000s, you were given a ledger book also along with an ATM card for you to withdraw cash. You occasionally have to update the ledger book in this machine next to the bank teller but most of the time, you don’t actually need to.
I was young and always thought that the banks were the sources of all the wealth of the country. It is true … technically. Back when banks were not available for most of the population, we kept most of our money in a safe or literally underneath the bed (as the saying goes). As more branches become available, most people realise its not economical or sustainable to store money this way and opted to do so in the safety of the bank. You could be robbed. Furthermore, the banks offered a “rate of return” on your money which normally means that if you store your money with them, you could get about 1% to 2% — much better than keeping the money underneath the bed where they don’t do anything.
However, I want to explore what do banks actually do and their contribution to us as ordinary people. Let’s find out!
Banks are Intermediaries and Use Our Savings to Give Out Loans and Invest in Assets
When you deposit your money in the bank, you might notice that the bank gives you some kind of interest return (though very small). Have you ever wondered how they make money? That’s simple. They take your money and give out loans to other businesses or people who borrow from the bank. Households will normally take up loans for their houses and cars, while businesses do so to expand their operations. They will all pay an interest rate on the loans.
The important point is that these interest rates on loans are normally higher than the interest rate they promised for your deposits or savings in the bank. In the finance world, this is called the net interest margin. For example, if you put your money in a fixed deposit with the bank that promised you about 4.0%, the bank will need to give out loans that have interest rates that are higher than 4.0%. Not only that, they need to take into account the cost of the whole process of issuing the loans out. They have to find borrowers, process the paperwork, and make sure everything is according to banking regulations. All of that involves employing people from different departments within the bank to make this work.
This is the same also for banks when they invest. They have to make sure that the investments they take, make returns that are higher than the 4.0% they promised you. Normally, banks do this through their own unit trust funds that take investors’ money and invest them.
In Malaysia, banks net interest margin is about 2.0% where they normally set interest rates on loans about 2.0% higher than the deposit interest rates they promised depositors.
Source: World Bank
Ordinary Malaysians and Businesses Are the Ones Providing True Value to the Economy, and Not Really Banks
Let’s put it this way. Banks provide value but not true value. What do I mean? I mean that without banks, you and I and the businesses around us would not be able to store and transfer money in an effective, efficient and secure manner. We need them to provide these services or we would have difficulty conducting our businesses. However, the true value actually lies in Malaysians working and building businesses, to produce goods and services that increases the value of the economy.
Think of the vegetables that you are eating now. Someone in Cameron Highland would have to plant these vegetables for your consumption, and they would only do so if you as a consumer wanted to eat it. It all starts with us Malaysians in producing things of value. Without the demand and supply in the market, banks would have nothing of value to provide and I would say they are the perfect example of using money to make money.
In the bigger picture, if you think deeply about it, banks are only facilitating the process of people and businesses conducting their day-to-day things to do. They don’t tell you as a consumer that you need to consumer vegetables, and they don’t produce the vegetables planted in Cameron Highlands. But if you need to pay for that vegetable from the seller, you would need cash from your account or do a bank transfer. Banks provide value to you, but not the true value. True value lies in the economic activities on the ground. And without that, banks will not be able to function.
But Banks Matter and Play a Very Big Role In ENABLING Malaysians and Businesses to Grow and Thrive
You are a small time business owner, trying to build a restaurant. How do you start? You decide on what you want to sell and came to a conclusion that Nasi Lemak with a fusion twist to it would bring in a unique taste and experience for Malaysians. You need to find a place to rent, staffs (cook, cashier, waiters, waitresses), equipment (wok, pots, pans, etc) and furniture (chairs, tables, decorations, etc). The problem is that you only have RM15,000 in savings. You definitely cannot afford all these upfront but you are confident that your business can take off in the future. What do you do?
This is where banks can play a big role. They have the funds that you need, but the risk is that you would need to pay an interest rate on the loan that you will take from them. However, without the funds upfront, you won’t even be able to build the business in the first place. And this loan could be worth taking up if you can make even more money with the business. If the interest rate on the loan is 4.5%, and you are generating a return of about 8.0% on your business, this is a good loan to take up.
The same can be applied to if you need to buy a house or car, you don’t have that much money upfront to buy these assets so you can borrow from the bank. This will allow you to earn more income in the future as you have a place to stay (security of a shelter above your head) and travel to other places to find work with a car. If you are confident that you can earn higher income in the future, then taking a loan will work in your favour.
Malaysia’s total loans stand at RM2.0 trillion according to data from Bank Negara Malaysia as of February 2023, which more than doubled from 2010.
Source: Bank Negara Malaysia
Banks Have Funded Purchases of Houses and Cars for Many Malaysian Households and Various Other Business Sectors.
Without the banks, many households in Malaysia would not have access to loans to purchase housing and cars that are important to them. Housing constitutes one of the biggest portion of total loans for households at about 34.2%, followed by cars (9.0%). Business sector loans come up to about 39.9% of total loans, and if we segmentise this further, we can see that the services, manufacturing and construction business sectors are the biggest recipients of loans in the country.
Source: Bank Negara Malaysia