How Banks Make Their Money

Artiesha Artis

Introduction to Business

Professor E. Baltas

How do they do it? The Banks at work

When we think of businesses today we rarely take the time to think of how they actually came into existence. Of course we understand that each business is founded on a thought and we also known that it takes at least fifty ideas to generate one successful idea. However, once those ideas are placed into actions and become some of the great institutions we have today we tend to forget about the general purposes of why that particular institution was founded. As we progressed in class there was one thing that kept me in deep thought when it came to businesses. This thought is the basis of my research and that thought is how is it that a bank can loan money and continue to make money?

First a definition Brittanica.com defines a bank as an institution that deals in money and its substitutes and provides other services. Banks accepts deposits and makes loans and derives a profit from the difference in the interest rates paid and charged. Simply put banks operate on trust. Trust that we provide when we put our money into an account and trust that the banks provide where they in turn distribute loans without knowing whether or not they will get that money back.

Another Question may be arising in your minds and that question may be how do we know that we can trust the bank with our money? As long as the FDIC which is the Federal Deposit Insurance Corporation a company that insures your deposits up to $100,000 through the Banking Insurance Fund, protects your bank your money is safe. Therefore if your financial institution fails for any reason the FDIC have several options to remedy this action however the most common one is to sell your deposit to another bank.

Now that you know your money is safe what happens when you want to take your money out of the bank? Generally this is not a problem, we know that we can always go to the bank and get our money. The problem arises only when everyone decides that they want their money all at once. Banks have what is called a reserve requirement. The reserve requirement is the percentage of money that a bank is required to hold in cash or deposit with a Federal Reserve Bank. Let me explain it to you this way, the current reserve requirement is 3 percent to 10 percent of a banks total deposit. So it breaks down like this, say a bank get a deposit of $100 and let's assume that the reserve bank's requirement is 10 percent, the bank can lend out $90. That $90 finds its way back into the economy through purchases and usually is deposited into another bank. Now this new bank can lend out $81 of the $90 deposited and the ripple continues to drift that way. So obviously this hundred dollars has more than tripled its value from beginning to end. However if everyone decided to pull his or her money out at one time there would not be enough money in the Reserve to counteract this catastrophe. Therefore Banks have more trust in us then we have in them.

There are several different types of banking institutions and it used to be that each of these institutions were quite distinct, however over time that has changed. We have Savings banks, savings and loans, cooperative banks and credit unions, which are classified as thrift institutions. Thrift institutions are financial institutions that specialize in the careful management of money. Each institution originally concentrated on providing services for those not covered by commercial banks. Savings and loans and cooperative banks were established in the 1800's