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Stable financial sector
cient organisation of the economy. However,
a situation in which there is a perfect match
between deposits and credits, is exceptional of
course. So, this implies a transformation of de-
posits before they will become credits.
How?
By a change of scale:
small deposits will be
grouped together for the purpose of offer-
ing ‘big’ credit amounts. The funds provid-
ed by the thousands of savers in Belgium,
taken separately, have no economic useful-
ness whatsoever. By putting those savings
together, the bank will be able to transform
them into credits and to provide funds to
those who are in need of money.
By a transformation over time:
short-term
deposits are transformed into medium and
long-term credit.
By a change of currency:
in some cases,
deposits labelled into a particular currency
will be transformed into credits labelled in
an other currency.
The transformation of deposits into credit im-
plies some costs for the banks. First, there is
the cost of operating, which includes among
other things the employees, the IT-systems
and the distribution network.
Then, there is the cost inherent of the risks im-
plied in the transformation process. There are
three risk categories:
Credit risk:
the borrower may go bankrupt
and lose his ability to reimburse. In some
cases, it will be impossible for the bank to
recover the whole of the credit amount.
Liquidity risk:
depending on the character-
istics of their deposits, savers have the pos-
sibility to ask for their money at a particu-
lar point in time. However, at that moment,
the bank must make sure that it will be able
to reimburse its creditors.
Interest rate risk:
a bank has a certain inter-
est rate margin it must try to keep at a posi-
tive level. This margin corresponds with
the split between the yield generated by the
credit interest rates and the cost of deposit
interest rates. Anyone who borrows money,
may opt for a fixed credit and hence for a
fixed reimbursement amount all through
the credit term. If the interest rate on de-
posits goes up however, banks cannot put
the cost of this on the borrowers. So, the
bank’s interest rate margin may become
negative.
A bank may opt to take the risks on itself. It
will make sure that there is sufficient capital
adequacy or a sufficiently high level of liquid-
ity margin (i.e. the extent to which it can meet
its short-term payment obligations).
In addition, the bank can opt for risk hedg-
ing, for instance by means of a swap transac-
tion, such as an interest rate swap. This implies
several transactions aimed at transforming the
fixed interest rate into a variable interest rate,
and thus an elimination of the interest rate
risk. It goes without saying that this risk hedg-
ing also generates costs.