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FRM Exam Part I · Banks

Structure and Functions of Banks for FRM Part I

Updated 11 October 2026 · Fact-checked

Banks take deposits and other funding, then lend and invest it. This is financial intermediation. Commercial banks focus on deposits and loans; investment banks focus on underwriting, advice and trading. To solve questions, classify each item as asset or liability, then trace how it earns or costs income.

Understand Structure and Functions of Banks

A bank is an intermediary. It collects funds from savers and lends them to borrowers. Savers want safety and easy access to cash. Borrowers want long-term money. The bank bridges the gap. This is financial intermediation, and it creates the risks you study in FRM: credit, liquidity, interest rate and operational risk.

A commercial bank takes deposits from retail and corporate customers, makes loans, and provides payment services. Its business is mostly the banking book. An investment bank helps firms raise capital (underwriting stocks and bonds), advises on mergers and acquisitions, trades securities and makes markets. It relies on wholesale funding such as repo, not insured deposits. Many large banks combine both in a universal bank structure.

The balance sheet shows how the bank works. Assets are what it owns: cash and reserves at the central bank, securities, loans, and trading assets. Liabilities are what it owes: deposits, borrowings, repo funding and bonds. Equity is the difference: Assets = Liabilities + Equity. Banks are highly leveraged, so a small fall in asset value can wipe out a large share of equity.

Banks earn net interest income: interest on loans and securities minus interest paid on deposits and borrowings. They also earn non-interest income: fees, commissions, trading gains, and advisory and underwriting revenue. Because assets are usually longer-term than liabilities, banks face maturity transformation, which creates liquidity and interest rate risk. They also face credit risk on loans.

The FRM tests this as foundational knowledge. Expect questions that ask which activity belongs to which type of bank, how an event changes the balance sheet, or which risk follows from a funding structure.

Key formulas to remember

Balance sheet identity
Assets = Liabilities + Equity
Always holds. Equity is the residual and absorbs losses first.
Net interest income (NII)
NII = Interest income − Interest expense
Interest income comes from loans and securities; expense comes from deposits and borrowings.
Net interest margin (NIM)
NIM = NII ÷ Average interest-earning assets
Use earning assets, not total assets, unless the question says otherwise.
Leverage ratio (simple)
Leverage = Total assets ÷ Equity
Higher leverage magnifies both gains and losses on equity.
Equity change from asset loss
Loss in assets ÷ Equity = % fall in equity
Liabilities stay fixed, so the whole loss reduces equity.

How to solve Structure and Functions of Banks questions

Use this order for any question on bank structure, balance sheets or income.

  1. 1Identify the institution: commercial, investment, or universal bank. Match it to its core activities and funding.
  2. 2List the balance sheet items in the question and mark each as asset, liability or equity.
  3. 3Apply Assets = Liabilities + Equity to find any missing figure.
  4. 4If income is asked, separate interest income, interest expense and non-interest income.
  5. 5Compute NII, then NIM or other ratios using the exact base the question names.
  6. 6For leverage or loss questions, remember liabilities stay fixed so equity absorbs the change.
  7. 7Name the risk created: credit, liquidity, interest rate, or market risk.
  8. 8Check that your answer is in the correct units and matches one option only.

Quickest way: Classify, then compute

When to use it: Use it for multiple-choice questions where time is tight and the options differ clearly.

  1. Underline the bank type and any numbers.
  2. Sort every item as asset or liability in your head.
  3. Do one calculation: equity as the plug, NII as a subtraction, or loss ÷ equity.
  4. Eliminate options that confuse deposits (liability) with loans (asset) or that mix up bank types.
  5. Confirm the answer is reasonable, for example equity cannot exceed assets.

Common mistakes in Structure and Functions of Banks

  • Treating deposits as assets of the bank.

    Deposits feel like money the bank holds, so they look like an asset.

    Fix: Deposits are owed to customers, so they are liabilities. The bank's asset is the cash or loan it holds against them.

  • Saying investment banks mainly take insured retail deposits.

    Students blend the two bank types in universal banks.

    Fix: Investment banks rely on wholesale funding such as repo and bonds. Retail deposits are the commercial bank model.

  • Using total assets as the base for net interest margin.

    It is the base shown on the balance sheet.

    Fix: NIM uses average interest-earning assets unless the question defines it otherwise.

  • Reducing both assets and liabilities when a loan loses value.

    Students assume the balance sheet shrinks evenly.

    Fix: A loss lowers assets only. Liabilities are fixed contractual claims, so equity falls by the full loss.

  • Forgetting non-interest income when asked about total revenue.

    Focus on loans and deposits hides fees and trading.

    Fix: Total revenue is NII plus non-interest income such as fees, commissions and trading gains.

Worked examples

Example 1

A bank has total assets of $500 million and equity of $25 million. Its loan portfolio loses $10 million in value. What is the percentage fall in equity, and what is the new equity?

Show the solution
  1. Liabilities = Assets − Equity = 500 − 25 = $475 million, and they stay fixed.
  2. The $10 million loss reduces assets to $490 million.
  3. New equity = 490 − 475 = $15 million.
  4. Percentage fall = 10 ÷ 25 = 40%.

Answer: Equity falls 40% to $15 million.

Example 2

A bank earns $90 million interest income and pays $54 million interest expense. Average interest-earning assets are $1,200 million. Fee and trading income is $20 million. Find NII, NIM and total net revenue.

Show the solution
  1. NII = 90 − 54 = $36 million.
  2. NIM = 36 ÷ 1,200 = 0.03 = 3.0%.
  3. Total net revenue = NII + non-interest income = 36 + 20 = $56 million.

Answer: NII is $36 million, NIM is 3.0%, and total net revenue is $56 million.

Exam tips

  • Know which activities define commercial versus investment banks. Option wording often swaps them.
  • Always check whether a question asks for average earning assets or total assets in a margin calculation.
  • In loss questions, treat liabilities as fixed and let equity take the whole hit.
  • Link each balance sheet feature to a risk: long loans funded by short deposits means liquidity and interest rate risk.
  • Read the sign and units carefully; equity changes are often asked in percentage terms.

Practice questions from Banks

Structure and Functions of Banks in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Structure and Functions of Banks: frequently asked questions

What is the main difference between a commercial bank and an investment bank?

A commercial bank takes deposits and makes loans. An investment bank underwrites securities, advises on deals and trades. Investment banks use wholesale funding rather than retail deposits.

What is financial intermediation?

It is the process of channelling funds from savers to borrowers. The bank takes deposits, lends them out, and earns the spread. In doing so it transforms maturity, size and risk.

Are loans assets or liabilities for a bank?

Loans are assets because borrowers owe the bank money. Deposits are liabilities because the bank owes customers. Equity is assets minus liabilities.

How do banks make money?

They earn net interest income from the gap between interest earned and paid. They also earn fees, commissions, trading gains and advisory income.