How Banks Work?

  • Jul. 20th 2020
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  • BankApply
How Banks Work?

Banks are omnipresent. They've been here for ages and dealing with a bank is a standard part of the life. From the young ages, we've been taught that a bank is a safe place where you can deposit money, earn interest and get a loan.

We never really think about how a bank functions. It's important to remember that bank is a business, and their goal is to make as much profit as possible.

In this article, we'll take a look at the standard banking services and how banks make money.

Current Account

A current account is a general-use account which allows you to do transactions, withdraw money from ATMs, pay your bills, etc. It's the most standard account that most of us have. A current account is something that FinTechs provide as well. 

Savings Account

A savings account, in theory, enables you to earn interest on the money you deposit on your account. However, with today's rates, it's pretty much 0% and has very few if any upsides. A savings account is a loan that you give to the bank, which the bank loans out with a higher interest to make money. Because you can usually deposit any amount and if it's not locked for any concrete period, the interest is also abysmal.

Loans

Another standard product is credit - banks aggregate capital and provide credit for consumers and businesses. Most FinTechs that provide current accounts don't extend credit.

How do banks make money?

As briefly described above, banks use the money you deposit on your savings account to give out loans or invest. If they're paying you 1% annual interest, and give out a loan with a 3,5% annual interest, they're pocketing the difference. 

Similarly, they may buy (for example) a treasury bond with a fixed interest of 5%. If they pay you 1%, they'll be making 4% return with the investment. This doesn't sound like a huge return, but if the amounts get really big, it's a lot of money. 

It's also a long-term business. If you think about mortgages and other long-term loans, then banks can make stable money for many years. 

Additionally, banks make money from various fees. You get charged for payments, ATM withdrawals, and so forth. These fees add up to a considerable amount.

The above is basically the main concept of how banks work - they act as aggregators of small amounts, and earn a profit on the larger sums either by loaning money out or investing. 

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