Teaching My Sons: How Do the Banks Make Money?

How Do the Banks Make Money?

imagine a bank is like a giant piggy bank that helps people save and borrow money. Here's a simple way to understand how a bank makes money:

Step 1: People Deposit Money

Deposits: Imagine lots of people put their money into the bank for safekeeping. This money is called "deposits."

Interest: The bank promises to give these people a little extra money, called "interest," as a thank you for keeping their money in the bank. For example, if you put $100 in the bank, the bank might give you $1 as interest at the end of the year.

Step 2: The Bank Lends Money

Loans: The bank doesn't just keep the money sitting there. Instead, it lends out a lot of this money to other people who need to borrow it. These people might want to buy a house (this is called a mortgage), start a business, or pay for school.

Higher Interest: When the bank lends this money, it charges the borrowers a higher interest rate than what it pays to the depositors. For example, if someone borrows $100, they might have to pay back $110. That extra $10 is the interest the borrower pays.

Step 3: The Bank Makes Money

Difference in Interest: The bank makes money from the difference between the interest it pays to depositors and the interest it charges borrowers. If the bank pays you $1 on your $100 deposit but charges someone else $10 to borrow $100, the bank earns the $9 difference.

Fees and Services: Banks also make money by charging fees for different services, like account maintenance fees, ATM fees, or fees for helping people manage their money.

Example to Illustrate

You: You put $100 in the bank.

Interest to You: The bank promises to give you $1 in interest after one year.

Borrower: Someone else borrows $100 from the bank.

Interest from Borrower: The borrower agrees to pay the bank $110 after one year.

Bank's Earnings: The bank pays you $1 but gets $10 from the borrower. So, the bank earns $9.

By borrowing money from people and then lending it out to others, banks help people save, invest, and manage their money while making money for themselves.

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