How Does a Bank Afford to Pay Interest on Savings Accounts?


Banks take in deposits

When a customer opens a savings account, he or she is looking for a safe, stable place to store money while earning a modest interest income. Banks, especially those guaranteed by the Federal Deposit Insurance Corporation (FDIC), provide that safe haven for money and pay a small return for the privilege of using the money while it remains in the account.

Banks loan out the money in accounts

While money sits in a bank's accounts, the bank uses that money to make loans to qualified businesses and individuals. The bank carefully evaluates each loan and credit card application it receives to ensure the highest likelihood of repayment; the bank then assigns an interest rate to the loan product and funds the loan using the money available in its deposit accounts.

Banks collect payments and pay interest

As the bank collects payments, including principal and interest amounts, from its loan customers, it credits a portion of the interest received to its interest-bearing deposit accounts. Because the interest rate banks charge to loan customers is considerably higher than the rate they pay to deposit customers, the bank keeps the difference between the amount collected and the amount paid as profit.

Banks rarely keep all deposits available in cash

Even though deposit account customers may request cash withdrawals at any time, banks very rarely keep the full amount of their account balances available for withdrawal; instead, the majority of the deposited funds are tied up in loans and investments at any given time. Depending on the line of business (commercial, industrial or personal, for example) served by the institution, banks generally keep between 5 and 15 percent on hand for cash withdrawals. These percentages are set by expert predictions and special software that determines how likely customers are to make withdrawals at any given time.

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