How Banks Work
Have
you ever noticed the vault when you go to the bank? A vault
is a room, usually at the back of a bank, with thick walls,
a heavy door, and a big lock. All banks have one.
When I was a kid, I thought the vault at my bank was where the bank kept all the money that people put into their accounts. I thought it was piled high with crisp green bills and shiny coins. Then one day I was at the bank with my dad, and the vault door was open just a crack. While my dad talked to a friend, I sneaked over to the vault to peek inside. Do you know what I saw?
There
was no money at all inside, not even a penny. Just rows
and rows of little metal drawers.
“There’s no money in the bank! There’s no money in the bank!” I shouted as I ran back to my dad.
Everyone in the bank stopped talking and looked at me. The bank manager ran out of his office, red-faced and excited. “Why are you telling everyone that the bank has no money?” he asked.
“Somebody must have stolen it,” I said. “There isn’t a single coin in the vault.”
The bank manager smiled and let out a big sigh. Then he explained to me how a bank works.
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Bank
customers store valuables in safe-deposit boxes. |
It turns out that the little metal drawers I saw in the vault are called safe-deposit boxes. A bank’s customers use those boxes to store their valuables, such as jewelry and important papers. Cash is usually kept in a separate, hidden area at the back of the vault. But I learned that most of the money people put into a bank isn’t kept inside the bank at all.
When you put money into a bank, it’s called making a deposit. The bank teller carefully notes the exact amount of your deposit. The cash you deposit is then mixed up with money other people have deposited. But instead of leaving that money in the vault, the bank lends it out. It lends money to people to help them pay for expensive things they can’t afford on their own, like houses or cars. Banks also lend money to help people start or expand businesses.
Banks
lend money to help people buy things like houses or cars.
People who receive these loans pay the bank back over time,
usually in monthly payments. They also pay the bank a little
extra money, called interest. The extra money the bank makes
from interest on loans helps pay for the cost of running
the bank.
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Sometimes people are surprised to learn that the money they put into a bank is loaned out to other people. I was. After all, it’s our money, not the bank’s. But the bank pays depositors for being able to lend their money. Those payments are also called interest, and they are based on a percentage of the amount that’s been deposited.
A bank doesn’t lend all of its depositors’ money. It always holds plenty of money back to make sure it has enough when people want to take their money out. Banks must obey strict rules about this. Also, a government agency called the Federal Deposit Insurance Corporation, or FDIC, insures deposits at most banks up to $100,000. That means that if your bank got into trouble and couldn’t give your money back, this agency would step in and pay you back, up to $100,000. That hardly ever happens, but when you open a bank account, it’s a good idea to make sure your money is insured by the FDIC.
Banks have changed a lot since I was a little girl. But they still take deposits and make loans, just as they did when I peeked into my bank’s vault so many years ago. Though I didn’t know it then, there’s one thing I know now. All your money may not be locked inside the thick walls of your bank’s vault, but it’s as safe as it can be.
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Interest Made Easy Interest on a loan is based on a percentage of the amount the bank is lending. Let’s say you received a loan of $100 for one year at ten percent interest. At the end of the year, you would need to pay back the $100 plus $10, because $10 is ten percent of $100. Loan
x Interest Rate = Interest Due to Bank
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Interest
on deposits works the same way, except this time around,
the bank pays you. If you deposited $100 into a savings
account that paid you five percent interest per year,
the bank would pay you $5 in interest at the end of
the year, because $5 is five percent of $100.
