The Great Balancing Act
A bank must have two sources of money in order to work:
- Deposits
The money that people, like you, entrust in checking, savings, CDs, and money market accounts - Reserves
The bank’s own capital that it keeps on hand–called a “cash reserve”–just in case a whole bunch of customers decide they need to clean out their accounts all on the same day
With these two sources of capital, a bank will either make loans, offer lines of credit, or invest in securities. The strategy is to earn more money by charging or earning interest than the money would otherwise yield if it were just sitting in a bank vault.
The following are some important characteristics about how the banking system works:
- A bank is required to keep a certain amount of “cash reserves” on hand to pay any depositors who want their money back.
- However, a bank may legally extend more credit than it actually has in cash reserves.
- A bank makes a profit by investing or lending money that is earning a higher rate of interest than it pays to its depositors.
- A bank also makes money by charging fees on the majority of its checking, loan, and credit card services.