Banks - How They Make Money
How Banks Make Money
Most of you like me would say that banks made their money by charging us consumers like wounded bulls for every thing we do from going into a bank to withdrawing our own money.
Banks create money in the economy by making loans. The amount of money that banks can lend is directly affected by the reserve requirement set by the Central Bank. This amount can be held either in cash on hand or in the bank’s reserve account with the Central Bank. To see how this affects the economy, think about it like this. When a bank gets a deposit of $100, assuming a reserve requirement of 10 percent, the bank can then lend out $90. That $90 goes back into the economy, purchasing goods or services, and usually ends up deposited in another bank. That bank can then lend out $81 of that $90 deposit, and that $81 goes into the economy to purchase goods or services and ultimately is deposited into another bank that proceeds to lend out a percentage of it.
In this way, money grows and flows throughout the community in a much greater amount than physically exists. That $100 makes a much larger ripple in the economy than you may realise!
Bank Loans
Banks are just like other businesses. Their product just happens to be money. Other businesses sell widgets or services; banks sell money in the form of loans, certificates of deposit (CDs) and other financial products. They make money on the interest they charge on loans because that interest is higher than the interest they pay on depositors’ accounts.
The interest rate a bank charges its borrowers depends on both the number of people who want to borrow and the amount of money the bank has available to lend. The amount available to lend also depends upon the reserve requirement the Central Bank has set. At the same time, it may also be affected by the funds rate, which is the interest rate that banks charge each other for short-term loans to meet their reserve requirements.
Loaning money is also inherently risky. A bank never really knows if it’ll get that money back. Therefore, the riskier the loan the higher the interest rate the bank charges. While paying interest may not seem to be a great financial move in some respects, it really is a small price to pay for using someone else’s money. Imagine having to save all of the money you needed in order to buy a house. We wouldn’t be able to buy houses until we retired!
Bank Income
Banks also charge fees for services like checking, ATM access and overdraft protection. Loans have their own set of fees that go along with them. Another source of income for banks is investments and securities.
Next we’ll be taking a look at banks and how they control the money supply.
4Quan
Warrior for Truth
Professor (things that make you go Hmm..)