Money in the bank might take the form of numbers on a computer screen or rectangular stacks of green paper in a vault. Either way, people have been putting money in the bank for the same reason for centuries: security.
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Although they’re obvious targets for robbers, banks are highly secure and, in the modern era, highly insured. On top of all that peace of mind, bankers will even pay you a little interest for the privilege of letting them hold your cash. The average annual percentage yield on a savings account is currently 0.24%, according to CNBC, or $1200 a year on a $5,000 deposit. Banks borrow money from their customers for dirt cheap — have you ever landed a loan for 0.24% interest? But what do they actually do with all the cash that they receive as deposits?Well, it’s complicated.
How Do Banks Make Money?
Your deposits are only a tiny part of the game. Although modern banks are massive, complex and highly diversified, they still make most of their money in three ways, according to the Corporate Finance Institute:
Interest income: Banks profit from interest payments that borrowers make when they pay back loans. This is where your cash deposits come in — but not in the way you probably think.
Capital markets income: Banks earn money through capital markets by providing services like underwriting, merger and acquisition advisory, and sales and trading services.
Fee-based income: Banks also make money by charging a variety of fees — many of which you know and hate — associated with their services and products, including checking and savings accounts, credit cards, mutual fund revenues, custodian fees and investment management fees.
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The Revolving Money Myth: Your Deposits Don’t Fund Bank Loans
Common mythology says that banks take the money that customers deposit into their savings accounts and lend it out to borrowers for a profit. The bank makes only the smallest interest payments on the deposits it receives, charges much higher interest rates on the loans it extends and pockets the difference as a handsome profit. Basically, in this scenario, banks act as middlemen, playing the matchmaker between savers who want to earn a return on their excess capital and borrowers who are willing to pay for a loan.
In painfully simplified terms, that’s sort of true, but only in the most indirect of ways.
Banks Create the Money They Lend
Banks don’t need your money to extend loans. The loans themselves create new money.
Each and every time a bank makes a loan, the laws of double-entry accounting require them to create a new account for the borrower and make a deposit equal to the loan amount.
According to Forbes, this means that banks create money every time they lend money. They’re able to do this because banks are allowed to lend much more money than they have.
The Money They Lend Isn’t Really There
Banks operate on a system called fractional reserve, which allows them to keep only a small fraction of the money they lend available on hand as withdrawable cash reserves. Also, the 1913 Federal Reserve Act requires banks to maintain the minimum cash reserves needed to clear outgoing checks.
One of the cheapest ways to meet those reserve requirements, according to Resilience, a program under the Post Carbon Institute, is through “retail deposits” — that’s the money you keep in your savings account. If they can’t attract new customers to borrow cheap retail deposits from, banks have to meet their cash reserve requirements by paying more to borrow wholesale deposits from the Fed.
In short, banks don’t take the money that you deposit, turn around and loan it at a higher interest rate. But they do use the money you deposit to balance their books and meet the necessary cash reserves that make those loans possible.
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This article originally appeared on GOBankingRates.com: What Do Banks Do With Your Money After You Deposit It?
The rest of your money (the majority of the bank's assets) is invested by the bank into vehicles such as consumer or business loans, government bonds and credit cards. Borrowers have to pay the bank back with interest. This process, in which banks distribute deposits out as loans, is called financial intermediation.
Some of your money is loaned to businesses, typically in the form of small business loans. Businesses pay interest to the bank, which is one of the ways banks make money. Part of your $100 bill also makes its way to other people, in the form of mortgages, car loans and personal loans.
It doesn't remain locked away in the bank vault – instead, the money you deposit into a savings account is used by the bank to make loans to other people and businesses in your community so that they have the money to pay for big expenses like houses and cars, or even to operate a business.
Banks use the major portion of deposits to extend loans. These loans are then recovered with an interest. Banks charge a higher interest for credit than deposits. Hence, the amount they receive is greater than the amount that they lend.
At the moment of deposit, the funds become the property of the depository bank. Thus, as a depositor, you are in essence a creditor of the bank. Once the bank accepts your deposit, it agrees to refund the same amount, or any part thereof, on demand.
Banks can't lend out all the deposits they collect, or they wouldn't have funds to pay out to depositors. Therefore, they keep primary and secondary reserves.
If you deposit cash, that money goes directly to your account and will be ready for you to use immediately. But for checks and other items that might need verification (to protect you and the bank), the money usually won't be available until the next business day.
Only a small portion of your deposits at a bank are actually held as cash at the bank. The rest of your money (the majority of the bank's assets) is invested by the bank into vehicles such as consumer or business loans, government bonds and credit cards.
Most deposits in banks are insured dollar-for-dollar by the Federal Deposit Insurance Corp. This insurance covers your principal and any interest you're owed through the date of your bank's default up to $250,000 in combined total balances. You don't have to apply for FDIC insurance.
A bank account freeze means you can't take or transfer money out of the account. Bank accounts are typically frozen for suspected illegal activity, a creditor seeking payment, or by government request. A frozen account may also be a sign that you've been a victim of identity theft.
When Does a Bank Have to Report Your Deposit? Banks report individuals who deposit $10,000 or more in cash. The IRS typically shares suspicious deposit or withdrawal activity with local and state authorities, Castaneda says.
Only the account holder has the right to access their bank account. If you have a joint bank account, you both own the account and have access to the funds. But in the case of a personal bank account, your spouse has no legal right to access it.
They look after money held in bank accounts, provide loans to people who need to borrow, and handle millions of customer transactions each day. These include in store and online spending, bills payments, wages and benefits, and high street cash machine withdrawals.
Banking, as many of us understand it, is built on a foundation of trust. When you deposit money in a bank, you're essentially lending to the bank. They pay you interest for this "loan" and then lend this money out to other customers at higher interest rates, pocketing the difference.
Have you ever wondered what happens to your money once you've deposited it into your savings account? You might be surprised by the way your bank or credit union puts the money to work. Once your funds are safely in your account, you become a creditor of sorts. In essence, you're lending the money to your bank.
If the bank deposited money to your account in error, it doesn't need your permission to remove those funds and deposit them into the correct account. The bank may also correct the error by exercising an offset, which allows a bank to charge the account for a debt owed to the bank.
Introduction: My name is Aracelis Kilback, I am a nice, gentle, agreeable, joyous, attractive, combative, gifted person who loves writing and wants to share my knowledge and understanding with you.
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