How banks make money

Banks profit from the difference between the interest rate paid to depositors and the interest rate banks recieve from loan repayments. Once a depositor deposits money at the bank, the bank then turns around and lends the money to clients for mortgage, personal, auto or business loans. This process is how money is created into the financial system which expands the monetary base. If a bank offers 2% interest on deposits and charges an average of 6% on loans, it keeps the 4% difference as profit. However, banks do not lend out all the money they have or receive because it is dictated by a central bank on how much banks needed to keep as reserves. Central banks such as the Federal reserve publishes a reserve requirement.

If a central bank posts a 10% reserve requirements on banks, that means that a bank needs to keep 10% reserves that cannot be loaned out. This restricts the flow of cash which contributes to inflation. If a central needed to expand the monetary base, one way to do this is by lowering the reserve requirements on banks which frees up money available in the credit market. Interest rates that banks charge on borrowers or payments to depositors are also governed by a minimum value which is the interbank rate. This rate is the amount of interest banks charge each other for loans. If the interbank rate is 4.4%, banks needed to pay below 4.4% interest to depositors or its money market clients to make a profit. Also, banks need to charge more than 4.4% interest on loans to borrowers to be profitable. Other than lending money, banks also generate income from fees such as convenience fees for non-bank ATMs, checking account fees or annual fees on credit cards.

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