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Banking 101: How banks work?
- Posted on September 25, 2020
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By Karan Kapoor
Have you ever come across the question, how banks earn money? How do banks work? They offer many things, many offers and yet they never go out of money?
The funny thing about how a bank works is because of our trust. We donate our money to a bank to keep it safe for us, and then the bank turns around and gives it to someone else to make money for themselves. Banks can lend considerably more credit than they have currency, lawfully.
How do banks Earn?
They take the money you loan them for a part and earn a pretty good return on it, then give you a portion of that return in the form of interest. So, every dollar that you put into your bank account makes them a little bit of money. Nevertheless, most of us have complete confidence in the ability of the bank to protect our money and to give it to us when we ask.
If a person deposits money into their bank account then the bank can lend that money to other people. The depositing customer earns a small amount of money in return (interest on deposits), and the lending customer pays the bank more money (interest on loans) in return. The bank takes the balance to make money for itself.
Banks are crucial for our economy. Banks have the primary purpose of placing the money of their deposit holders to use by lending it to those who will then use it to purchase houses, companies, take children to college, and several other uses.
Once you deposit your money into the bank, your money goes into a large pot of money along with everyone else's, and the amount of your deposit is added to your account.
The merchant charges a small percentage of the money to the bank which issued the card, called an interchange charge, each time you swipe a card at a store. That is around 1.8% for credit cards, although it is closer to 0.3% for debit cards. It's a massive income source for banks, provided that Americans invest more than they earn.
Those are the costs paid to you by the bank for ATM fees, overdraft fees, late payment fees, fines, fees, and more.
Banks can also be more actively involved in the financial business, managing stock or bond transactions, as well as all the shares trade itself. Banks can also handle derivatives such as options and also act as stock market managers, where they choose to sell shares and also purchase them for sale to others.
These days banks are even indulging in insurance, as are a number of other financially linked practices such as trusts and estate planning. Because of their very broad asset base and finance experience, banks are well placed to meet a wide variety of financial needs, but with the ease of realising that you are dealing with a tightly regulated entity where confidence is at the forefront, it is really what banks are all about trust protection.
The cost incurred by banks?
There are a lot of costs of holding a deposit. Maintaining surveillance services, drug marketing, ATM networking, and call centre staffing. All of these, however, are dwarfed by the cost of maintaining physical branches, which accounts for most of the cost to the bank.
Organisations delivering online-only or branchless banking (such as Simple!) can keep running costs lower and invest their money more customer-friendly.
To sum up, a bank operates by paying small amounts to customers to lend them money and then to lend the money to others for bigger sums. We control the whole cycle and then maintain the gap between the big amount (interest on loans) and the small amount (interest on a savings account).
