The Business Of

Banking | Barclays | How Do They Make Money?

Morning All!

So yesterday, we started Part 2 of The Business Of Banking. And our focus this week is on Barclays. We saw that whilst Barclays is a massive retail bank - the 5th largest mortgage provider in the UK and a leading credit card provider. It also does a huge amount with businesses too – it ranks 7th in terms of investment banking fees globally!

Now, the chart below shows us how Barclays’ revenue is split between its 3 main sources;

1. net interest income - basically the interest charged on loans,

2. fees - investment banking/wealth management/credit card fees, and,

3. trading income - the spreads charged on market making.

Today, we’re going to focus solely on net interest income. One, because it’s Barclays largest revenue source. Two, because we saw how investment banks and market makers make money in The Business Of Goldman Sachs last time around. And three, because I’m sure many readers will have absolutely no idea what net interest income means! Hopefully that’ll change by the end of today. So without further ado, let’s crack on!

I Give Barclays My Money… What Do I Get In Return?!

Okay so, net interest income. To figure out exactly how this works, I think it’s best if we start from the beginning. The image below (you saw a similar version last time in The Business Of Goldman Sachs), reminds us of how retail and corporate banks work.

A bank like Barclays needs funding in order to do anything. And funding really comes in 3 forms; (i) deposits from individuals and businesses, (ii) debt from other banks, and (iii) other forms which we don’t need to get into now. And then Barclays will use these funds in 3 ways; (i) give loans to individuals and businesses, (ii) keep some cash with the central bank, and (iii) other ways which again we don’t need to get into now!

But here’s a question - how many deposits and how much debt do Barclays actually receive? Well, let’s start with deposits. In 2022, the total amount of money that individuals and businesses had in their Barclays bank accounts (deposits) was an absolutely staggering £546 billion! And this amount has grown considerably since COVID for a multitude of reasons - which you can read more about here.

Now in terms of debt, Barclays also had a mammoth £184bn from other banks. As a reminder, when I say debt here, this is where Barclays will say to their banking friends – ‘Hey Friends, we’re looking for a few million/billion. We’re going to issue a bond for this amount. We’ll pay you all back after 3 months. And with a bit of interest on top!’

Okay so, individuals and businesses have clearly been happy depositing lots of money with Barclays. But question - are these Barclays customers giving Barclays their money for free? Of course not! Individuals and businesses who deposit their money at Barclays are expecting some kind of return – in the form of interest!

As the screenshot (from Barclays annual report) shows, the bank paid £3.573 billion in interest for their deposits. And £3.240 billion in interest for their debt.

So, what kind of interest rate is that? Well remember, Barclays had £546 billion in deposits. And paid £3.6bn interest. Which means Barclays paid an average interest rate of 0.7% on deposits (3.6 / 546). And then in terms of debt, the bank had £184bn in debt, which they paid £3.2 billion in interest. Which means Barclays paid an average interest rate of 1.7% on debt (3.2 / 184).

So, here’s a question - Barclays paid an average of 0.7% interest on deposits in 2022 - will they be paying 0.7% interest on deposits in 2023? Well, to get an idea of that, all we need to do is go to their website and see what kind of interest rate we’d get at Barclays if we deposited our money with them today! So let’s do that!

In the screenshot below, we have the interest rates that Barclays pays on their two main savings accounts (the Rainy Day Saver & Everyday Saver). And we can see that whilst savers get a higher interest rate for their initial deposits, for any cash over £5k in the ‘Rainy Day Saver’ and over £10k in the ‘Everyday Saver’ - 1.15% seems to be the interest rate that Barclays would pay on most of their deposits.

So, will Barclays’ average interest rate paid on deposits be 0.7% in 2023? No way - it’s going to be higher! And the main reason here is because interest rates have been rising!

As I’m sure most of us will be aware, the Bank of England’s base rate has increased from 3.5% (Jan 2023) to 5.25% (now). And these interest rate hikes have led to UK banks raising their interest rates in a bid to win customer deposits! For those interested, I recommend giving those articles a read!

Barclays Gives Me Money… What Do They Get In Return?!

Alrighty, so that’s the first part covered. Barclays have £546bn in customer deposits. And they pay their customers some interest on these deposits. Now, the second part we’ll look at is loans. Because in order for Barclays to make revenue themselves, they need to make some loans! How many loans? Well in 2022, Barclays had loaned out 73% of their deposits – totalling £399bn.

This 73% is commonly known as the loan-deposit ratio. And banks try and strike a balance with this ratio. A higher figure means banks are handing out more loans and are able to generate more revenue. But too high a figure can land banks in trouble – and we’ll see on Thursday how important this ratio is when we discuss the collapse of Silicon Valley Bank!

Now, the second question to ask is – where did these loans go? Were Barclays giving these loans mainly to individuals for mortgages? Or to businesses for investments? Or does credit card borrowing come under this?

Well, the answer is yes to all three questions! As we can see from the chart below, ~£174bn of Barclays’ loans go to businesses (wholesale loans). Another ~£174bn goes to individuals for mortgages (home loans). And then the remaining ~£51bn is made up of the credit card borrowing that Barclays has on their credit card business.

Okay, so we’ve seen that 73% of deposits are handed out as loans. But what about the other 27% of deposits? And all that debt Barclays received from banks too? Where does all of that go? Well, Barclays keep most of that remaining cash at the central bank (the Bank of England).

And the main reasons for this is because banks kind of have to! Central banks like the Bank of England order commercial banks like Barclays to maintain a minimum level of ‘reserves’. And these requirements are put in place to make sure Barclays and other banks can meet their financial obligations and maintain stability. You can read more about this here!

Alrighty, so we’ve what Barclays do with all their funding (deposits and debt). But here’s a question - do Barclays hand out these loans for free? And do they just keep their cash at central banks for free too? Of course not! Barclays charge an interest rate to individuals and businesses whenever they take out a loan!

And the screenshot below shows, Barclays received £13.376 billion in interest from the loans they gave customers in 2022, and £2.916 billion in interest from the cash they had with central banks.

So, what kind of interest rate is that? Well remember, Barclays handed out £399 billion in loans. And received ~£13.4bn interest. Which means Barclays received an average interest rate of 3.4% on their loans. And then in terms of cash at the central bank, Barclays had £256bn in cash at the central bank, which they received ~£2.9bn in interest on. Which means Barclays received an average interest rate of 1.1% on their cash at the central bank.

And what we’ve just seen is vital. Absolutely vital for how banks make money. The interest rate that banks RECEIVE on loans is higher than the interest rate that banks PAY on deposits. If Barclays was paying 3% on deposits and only making 1% on their loans, they wouldn’t be making any money! And this crucial difference between the interest rate banks receive and pay is called the net interest margin. I highly recommend giving this article a read to understand more!

Interest Income - Interest Expense = Net Interest Income!

Now, let’s put this all together. The graphic below gives us all the interest expenses Barclays PAYS on the left hand side (£8.5 billion) and all the interest income Barclays RECEIVES on the right hand side (£19.1 billion). And subtracting the expenses from the income gives you the bank’s NET interest income of £10.6 billion!

The below screenshot shows us where these numbers come from in Barclays’ 2022 annual report…

… and that is pretty much that! Net Interest Income (NII) is a pretty complicated topic to understand initially. And so don’t worry if this takes a bit of time to digest. I had no idea what NII was before I started working in asset management. But I’m hoping for those who’ve made it to the end, you now understand a little better what net interest income actually means. And how a bank like Barclays makes most of their money!

On Friday, we’ll actually do a part 2 of Net Interest Income. And look at how Barclays’ NII has grown over the years. And what the main drivers of this revenue are!

7th Nov 2023

Nigel Jacob CFA