Monday, November 2, 2009

How Banks Work

First of all the question should arise in anyone's mind? Why do we need bank accounts?

Why do we keep our money in banks and not with ourselves?

Now the banks work in this way.

We give our money to banks and the banks offer those money to someone else for investing and in turn they take some interest from them and also offers interests to us. So, Because of that interest we are interested in banks. Moreover, it is easy to carry debit cards or cheque instead of cash in our hand.

Banks give loans to the person who requires it so that one can buy home, land or have a business. For this loan, they take certain interest for that amount offered. Similarly, Banks also offer us interest for the money we have invested with them. Banks are critical to economy as they create money by making loans. The amount of money that banks can lend is directly affected by the reserve requirement set by the Federal Reserve. The reserve requirement is currently 3 percent to 10 percent of a bank's total deposits. This amount can be held either in cash on hand or in the bank's reserve account with the Fed.

 Banks work because of our trust in them.We trust that banks will give our money back when we will need them back. But in this process, we forget that bank is also giving that money to someone else. There are different types of banks.

Savings Banks are the ones which were formed for saving of the people who had low incomes.
Cooperative Banks were established to make it possible for the factory owners or lower income people to buy their own home.
Credit Unions were usually started by people who shared a common bond, like working in the same company or living in the same community. The credit union's main function was to provide emergency loans for people who couldn't get loans from traditional lenders. They were like savings for emergency purpose.

Now the question arises how does bank make money? The answer is really simple. They are just like any other business having a product of money. They sell money to other business and take interest which is obviously higher than what they give to the depositors. This way they earn more than they lose. Obviously, The interest rate depends on how many people want to borrow money from banks. 

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