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The financial crisis that started in 2007 has led to a re‐thinking of financial regulation and supervision. One major lesson of the crisis is that supervisors should be “asking the big questions” (FSA). These are typically questions that are difficult to address, as they require a deep understanding of bank business models. The purpose of this paper is to provide the recent shift in prudential supervision towards the analysis of bank business models with a sound economic basis.

The paper reviews the economic literature on banking in order to answer what the authors deem to be the three central questions when analysing business models.

The bottom‐line for supervisors, in the authors' view, is that it is essential to understand where the profit comes from and what risks the bank or the banking sector is exposed to in generating those profits.

Analysing bank business models goes beyond the traditional approach to prudential supervision, which mainly focuses on the adequacy of bank capital, liquidity and risk management. The analysis of business models implies a different approach to risk, starting from understanding a bank's activities, customer groups, distribution channels and sources of profits.

This paper contributes to bridging the gap between the economic literature on banking and the needs of bank supervisors. To the authors' best knowledge, this paper is the first addressing this particular issue. By giving an overview of the recent literature on banking that is relevant for understanding bank business models it helps to provide supervisors with a sound economic basis for assessing banks' business models.