Banks have four primary sources of income:

• Lending. As a group, banks get money from deposits, which are primarily short-term in nature, and on-lend it to borrowers for long periods. This results in a co-called maturity transformation: short-term money is transformed into long-term one. This is the main function of commercial banks in the economy. For this operation to be profitable, average short-term interest rates during the tenor of an average loan should be less than long-term interest rates. Banks lend money to borrowers of different credit quality, with the rate of interest rate charged corresponding to the credit rating. Higher interest rate is justified and compensated for by higher rate of default of riskier borrowers.
• Cash management. Managing cash (which basically means keeping and optimizing operational cash balances and processing payments) for clients is a source of stable and, what is very important, risk-free income for banks (they do not put bank's capital at risk here).
• Trading. In this area, banks execute transactions for their clients and also for their own account (this is called 'proprietary trading'). While the first activity is risk-free for the bank (it earns its income by charging transaction fees), the second one is very risky (the bank risks its own capital here). Creating and selling derivative products belongs in the area of trading. It can be risk-free (when the bank acts only as an intermediary) or risky (if the bank takes one side of the transaction).