Something that everybody uses is a bank to store their hard-earned money, but have you ever wondered how the bank uses that money and invests it to improve their own value?
Banking institutions are the service that will be the bridge between depositors and Borrowers.
When they accept deposits and put these funds into an investment, banks have the potential to earn profits whilst also allowing them to support economic development and economic growth.
Depending on the investments that they make will ultimately depend on their profitability and where they choose to put their money. Here are all the details on where the bank invests money (see also ‘How Do Investment Banks Make Money?’).
Investing Bank Deposits
A bank will accept deposits and invest those funds, within the legal parameters by federal and state agencies, there are many commercial banks and savings and loan associations that will go this route.
There were over 4000 commercial banks and savings and loan associations registered in 2021.
In terms of your money, this isn’t just sitting in a safety deposit box with your name on it. Instead, the money is pulled together to put into investments.
Banks and institutions are required to maintain 10% reserves for the deposits, whilst the exact percentage will depend on the type of deposit.
Balance can be invested in a number of options such as real estate loans, commercial loans, consumer loans, and government Securities, and a profit will be determined by what is earned on the investments by way of the spread.
How they choose to invest this money will depend on the current economy and where it is strongest and weakest.
Real Estate Loans
You may be aware of the 2008 recession, or in the film The Big Short and know that banks put their faith in real estate.
Whilst this was an occasion where the housing bubble burst, typically long-term loans on properties such as housing and farmland is a safe option, with a fixed-rate mortgage carrying a risk if interest rates were to rise.
In the event of rising rates, you find the interest on deposits will typically rise, which will squeeze the spread between deposit rates and the loan.
Banks can compensate for any risk by issuing out variable rate mortgages or selling their mortgage portfolio to a Government Agency, such as the Government National Mortgage Association.
This will create security backed by the mortgages, and the bank will continue to make money by servicing the loans it has sold.
Government Securities
A bank is able to invest in government securities, either at a local, state, or federal level, which offers some of the highest degrees of safety.
Within this, you will find Treasury bills which are short-term instruments that have a maturity of one year or less at the point at which they are issued.
Treasury notes can carry a 1 to 10-year maturity when they are issued, and a Treasury bond will have a maturity of up to 40 years.
In the US, if the debt is considered to be safe, if and in times of economic uncertainty a bank will make fewer loans and then put their assets back into the government securities.
For example, when the world was dealing with the COVID-19 pandemic, the Federal Reserve made a large purchase of US government securities, which enabled them to support financial markets, households, and employers.
Commercial And Consumer Loans
Businesses will typically request a loan from the Bank. These are important as they are a vital source of income. Businesses are typically depositors, so banks can track their activity as well as their credit score.
You find that business loans are either fixed amounts or used as a line of credit for short-term financial requirements.
Banks also can earn significant income from a consumer loan, as consumers will borrow for certain items like furniture, vehicles, appliances such as kitchen installation, and several other purposes.
One of the most profitable methods for a bank to invest assets is by issuing a credit card. Most people will use a credit card for the most expensive purchases where they don’t necessarily have liquid cash available to spend.
With rates that are well above what a bank will pay for deposits, the spread becomes large and the margin for profit is generally high.
How Else Does A Bank Earn Money?
Some bank accounts will charge a monthly fee, and in return, you might receive some perks such as travel insurance, a better rate of interest, or cash back.
Account holder fees are not as common as they once were, but she’s still made a considerable contribution to a bank turning.
For example, Bank Of America’s Advantage Plus checking account will charge $12 a month for maintenance. If you were to tally those fees up over the year, it would cost you $144.
Banks also charge fees for certain types of actions or an era that you make with your account.
For example, overdrafts are a common way that most people will be penalized by their bank.
However, you might even enroll in an overdraft protection scheme which will cost you $30 every time that you need to overdraw your account. Even if you opt-out you might still need to pay these fees.
Another common penalty is if you bounce a cheque. Or perhaps you need to replace a lost or stolen card or have late payment penalties on a loan.
There are many ways that a bank can take money away from you through penalties or fees.
Final Thoughts
Now you know all the ways that will look to invest your money, and why some methods are more profitable depending on the state of the economy.
Using a bank has a benefit over simply keeping your money, and using the free services can be an incentive to put your trust in them.
However, other than using your money for local, state, or federal investment, there are several ways that a bank can seek out a little more of your money if you fail to adhere to their rules.
As long as you ensure you are on time with your payments and don’t go into overdraft, a bank will be making its money elsewhere.
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