Explain the process through which banks make money, both when lending money to borrowers and when accepting deposits from savers. Illustrate with an example for each case.
Answer by Student
Banks make money through two primary channels:
lending money to borrowers
accepting deposits from savers.
Lending money to borrowers
When individuals or businesses borrow money from a bank, they are required to pay back the borrowed amount along with an additional sum known as "interest."
Similarly, when people save their money in a bank, they are rewarded with "interest" as a token of appreciation for entrusting their funds with the bank.
- For instance , if someone borrows ₹50,000 from a bank at an interest rate of 12% per annum for two years, they will have to repay ₹56,000 (₹50,000 + ₹6,000 interest). In this case, the bank earns ₹6,000 as its profit from lending money to the borrower.
- When individuals or businesses borrow money from a bank, they are required to pay back the borrowed amount along with an additional sum known as "interest."
- Accepting deposits from savers.
On the other hand, consider an individual who deposits ₹30,000 in a savings account with an interest rate of 5% per annum.
After one year, they will receive ₹31,500 (₹30,000 + ₹1,500 interest) as their balance.
- Here, the bank pays ₹1,500 as interest to the saver for keeping their money with the bank.
The bank's money-making trick lies in charging borrowers a
rate than the interest it pays to savers.
This difference between interest earned on loans and interest paid on deposits is known as the "
net interest income
- The larger the margin between the two, the more profit the bank makes.