Question

Explain the difference between a bank's loans and its borrowings.

Short answer

A bank's loans are funds that it lends out to its customers, earning interest on these loans. A bank’s borrowings, on the other hand, refer to money that the bank acquires from different sources, including customer deposits and interbank loans, and uses to provide loans and make investments, paying interest on these borrowings. The key difference lies in the flow of money - out of the bank for loans and into the bank for borrowings.

Step-by-step solution

Definition of Bank's Loans

Loans refer to the money that banks lend out to clients or customers. These are often in the form of personal loans, mortgages or business loans. The borrower is obligated to pay back the loan amount along with the charged interest over a predetermined period.

Definition of Bank's Borrowings

Borrowings, in contrast, refer to the money that banks acquire from different sources. These sources can include deposits from customers, interbank loans, or borrowings from a central bank. These borrowed funds are then used by the bank for various purposes such as providing loans to other clients or making investments.

Contrast Between Loans and Borrowings

The primary difference between a bank's loans and borrowings lies in the flow of money. When a bank provides loans, money flows out of the bank to the borrowers, earning the bank interest over time. On the other hand, with borrowings, money flows into the bank, as it obtains funds from various sources. These funds form the resource base of the bank, which it then uses to make loans and other investments, paying interest on those borrowings. Thus, a bank's profitability is often decided by the interest rate spread between its borrowings and its loans.