How Do Banks Work Anyway?

We’ve been talking about banks and savings all the time but how do banks work anyway?

I’ve always wondered how banks make money if they just keep my money there and even pay me interest. The thing is, they don’t just keep the money there.

A bank after all is a business, and the point of business is to earn a profit – to make money. So how exactly do banks make money? I’ll try to explain it and I’ll try to make it simple. Actually, it is simple anyway.

The money that you deposit in the bank is lent to people and businesses, in the form of car loans, housing loans, personal loans and business loans. This is also the reason why there is a minimum maintaining balance for bank accounts. This allows bank to establish how much money they can lend. If a bank has 1,000 depositors with a minimum maintaining balance requirement of 1,000 pesos, then the bank is guaranteed that to have 1,000,000 pesos available for lending; the bank knows that at least this much money will not be removed from the system and can be sold in the form of loan products.

Loan products carry interests upwards of 10% p.a. A car loan for instance usually has an annual interest rate of 8-15%, depending on the bank. A housing loan usually has an adjustable interest rate ranging from 10-15%. And how much do you get out of your deposit? You’d be lucky to get an interest of 1% p.a. For every 100 pesos that you deposit and the bank lends, the bank earns 15 pesos, keeps 14 pesos and gives you 1 peso. And this is your money.

But no… Let’s not vilify the banks. They need to earn that money to pay for their employees and all operational expenses. And they don’t lend all of your money. The Bangko Sentral ng Pilipinas, which is the regulatory authority for the banking industry, requires banks to have some capital in reserve, to make funds liquid – or easily available – to the depositors, in case they want their money back of course. They also invest some of the money to get bigger returns, but again not all.

Additionally, banks are conduits for economic growth. Imagine, if there were no banks and a big business would need to borrow money, they would need to approach each individual and ask if they can lend them some. It would be a mess! Banks make it easier to pool funds together and make them available for lending. Lending – and other financing activities – allows business to expand, sell more goods, create more jobs, and ultimately provide more people better earning opportunities. As an added bonus, banks help you save money, too. 🙂

So every time you pass by a bank, would you still see it the same way that you did before? 🙂

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About Benedict Bernabe

Benedict Bernabe, 27. Benedict has a Master's degree in Development Studies from the University of Melbourne, Australia and a Bachelor of Arts degree in European Languages, cum laude, from the University of the Philippines Diliman. He has worked with the United Nations in the Philippines as the Community Facilitator of the Community of Practice on HIV&AIDS. He worked with Standard & Poor's Capital IQ, a financial information company, as researcher, translator and quality analyst in the investment research team. Prior to this, we worked at IBM Business Services. Benedict is a certified yoga teacher.

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