Understanding Banks: Start With the Basics

Motley Fool analyst Matt Koppenheffer sits down with Rick Engdahl for a side-of-desk interview about banks. Are they really that hard to understand? Can the big banks be trusted? Join us for a discussion that sheds some light on banks from Citigroup to Wells Fargo, as well as some of the smaller players.

Many investors shy away from the complexity of banks. In this video segment, Matt reveals that, while some aspects of the industry can be confusing, the bulk of it is actually fairly straightforward, consisting of the deposits, loans, and fees that everyone is already familiar with on the consumer side.

A full transcript follows the video.

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Matt Koppenheffer: One of the funny things for me is that, for investors when they look at banks, that's a lot of the reaction. "Oh, they're too complicated. I can't understand it."

I can understand where people are coming from, for sure, but spending a lot of time looking at banks, I have a very different viewpoint from that. Even when we look at the big banks, most of their business, most of their revenue, comes from the really simple, basic-banking business, which is you take money from depositors -- or you "get" money from depositors. If I say "take," that may sound a little bit bad, in terms of the banks.

You get money from depositors, and you turn around and you lend that money out to people, to buy homes, for student loans, for business loans; all these kind of loans. That business, of taking deposits and lending it out, that's about 50% of the business for even the biggest banks out there -- J.P. Morgan (NYSE: JPM  ) , Bank of America  (NYSE: BAC  ) -- this is half of their business.

Then, the other half of the business, it's fee-based businesses. In some cases, this is the stuff that people hate, like overdraft fees and that sort of thing, but a lot of it, too, is things like transaction processing. When you make a transaction in X given location, it's got to figure out a way to work its way through the banking system, and get that money from wherever your money is, to wherever you just spent it.

There are fees that happen within the system there, that gets the money from one place to another, and banks make fee money on that. That's pretty straightforward, good business.

There are credit cards. I have one of those miles credit cards, where I pay a fee every year, and I get a lot of miles, and I get a lot of use out of it, so I'm happy to pay that fee. That fee is another part of the banking fee.

When you add these all up, even when we look at a bank like J.P. Morgan, which I think people look at as a particularly complex bank, that all adds up to about 80% of its revenue. That's even before you start touching any of the trading and derivative stuff that really gets hairy for people.

When we look at the next tier of banks -- that would be like a US Bancorp -- we would consider that a super-regional, or BB&T and on into the smaller banks, then the concentration of what I would see as the easier-to-understand businesses, that expands to being most of the business.

At the very top end, you have a slice of the banks that is harder to understand; but even for those, most of the business I feel like is pretty basic.


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