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The Great Balancing Act
"Banks have been posting record profits for years, but
what's good for a bank's bottom line may not be good for
yours."
- Nancy Lloyd, author of
Simple Money Solutions
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.
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