Banks typically make money by borrowing and lending. They borrow from people who want to deposit and from that deposit they lend money to other who want to borrow to make home or factory. Liquidity is essential in all banks to compensate for expected and unexpected Balance Sheet fluctuations and to provide funds for growth. Commercial or conventional banks are required to hold a sufficient proportion of their assets in the form of relatively riskless instruments for monetary control purposes. (To hold reserve assets, and to maintain their reserve asset ratio). Historically, Central Banks’ changed the level of minimum reserve requirements to directly affect levels of liquidity and the price of short-term funds. Normally, the source of liquidity of conventional banks is deposits. Almost in all conventional banks there are some regulations about how to use these deposits. About eighteen and half percent of this deposit is used for cash reserve required (CRR) and statutory liquidity reserve (SLR) which is called statutory reserve as whole. SLR is like fixed deposit. Rest of that deposit which is almost eighty one and half percent is used in investment. Banks lend to people from this money. But there is a policy which is called Advance Depository Ratio which permits to lend 80% of that deposit. Banks generally give three kind of lending, retail finance which has interest rate of about 17%. They also give corporate loan which has interest rate of about 14%- 16% and SME ( small media enterprise) which is about 16%-17%.There is another regulation to keep one percent to two percent as provision. It is kept as a safety which is used in case of bad debt. If there occur any kind of bad debt then this money will cover the loss but if there is no bad debt then it will add as profit in profit account. Treasury department do regulate bank liquidity management. It also does the job of asset liability management. Banks mix the deposit makes long term deposit which is called term deposit, formed 25%- 35%. The rest percent they use for current deposit. Deposit is not only one source of liquidity of conventional banks. There are also some other instruments like Call Money. In Call Money one bank lend money from another bank and thus they manage their liquidity. Another source of liquidity is issuing bond from central bank. They do it at fixed interest rate. They issue conventional and non-conventional subordinate bond. They also use the mechanism of repo and reverse repo.
Conventional bank do profit about 1%-3% over cost of fund. Cost of fund is determined by treasury department. Adding up the provisional cost and administrative cost with the cost of fund, banks determine the interest rate for their different kinds of borrowers or clients in which they include their percentage of profit. This is called pull rate.
Conventional banks do their profit by interest sharing whether Islamic banks do their profit by profit sharing in another process or by other instruments.