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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:
Answer by Student
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Banks make money through two primary channels:
lending money to borrowers
and
accepting deposits from savers.
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Lending money to borrowers
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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."
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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.
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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.
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On the other hand, consider an individual who deposits ₹30,000 in a savings account with an interest rate of 5% per annum.
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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.
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The bank's money-making trick lies in charging borrowers a
higher interest
rate than the interest it pays to savers.
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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.
