What is a Bank? How does it function?

Bank functions on the trust and belief that the customers have on them. (Not many knew this, were you one of them?? I was!!!).

All that we do is we deposit our hard earned money in bank trusting them that they will respect our cheques and will return us our money when we want. We have a sense of security with the banks that the money is safe with them rather than with us. This is not the only reason for keeping the money with the banks. They provide us the opportunity to access the money at our ease (ATM) and also they provide many facilities. But the most important thing is Banks provide us Interest for the amount that we have deposited. Banks do provide the convenience for us to do loads of things with the money which we would not be able to do if we had kept the money with ourselves without trusting the banks.

From webster’s dictionary, Bank means “an establishment for the custody, loan, exchange, or issue of money, for the extension of credit, and for facilitating the transmission of funds”. The main purpose of Bank is to loan out the money to public in order to facilitate their spendings. When money is deposited by an individual that money goes to a pool of money where others also have deposited and the account of the individual is credited with the money so that when he gives the cheque it will be honored or he can withdraw money whenever he needs it. Interest will be provided to the amount that the individual has deposited.

What Bank does is, for every Rs.100 it has got through deposits it can lend Rs.90 and it should keep Rs.10 as reserve. This reserve amount is decided by the Central bank of the nation i.e. RBI for India. RBI governs all the banks in India. Banks provide lesser interest to the amount deposited than the interest it charges for the loan. The interest that is provided to the amount deposited varies depending on the type of account and how long the money is with the bank. Generally for savings account it is around 7 – 9% depending on the tenure and the various loans that it provides customer are Home loans, education loans, vehicle loans and so on. The interest for each of this also varies. Since the bank has Rs.100 has deposits, RBI also gives money to Banks and charges them interest. Generally it is up to 9 times the bank gets money from RBI. So RBI gives bank Rs.900 if the bank has Rs. 100 and all that bank has to do is just keep Rs.10 as reserve and lend out Rs.990. Bank loans the money out to general public and gets it back and returns the money back to RBI making some profits.

How does Bank make money? Banks are also a type of business. They make money on the interest they charge on loans because that interest is higher than the interest they pay on depositor’s accounts. The interest rate a bank charges its borrowers depends on both the number of people who want to borrow and the amount of money the bank has available to lend. Loaning money is also inherently risky. A bank never really knows if it’ll get that money back. Therefore, the riskier the loan the higher the interest rate the bank charges. While paying interest may not seem to be a great financial move in some respects, it really is a small price to pay for using someone else’s money.

Bottom line is : Banks just work on TRUST and nothing else. RBI and Depositor’s trust bank and provide their money. Bank in turn trusts its customers and expects them to pay back the amount that it has lent. If someone defaults in the middle the whole setup goes for a mess. If someone has a account in the bank that means he is trust worthy.

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One thought on “What is a Bank? How does it function?

  1. advik says:

    im a student and banking is my project im pretty sure that people would also like to know about the types accounts and services..

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