Wake up, eat breakfast, do work, go home. A usual routine. And then at the end of the month, collect salary, file taxes and then put our savings in the bank. And then back to the usual routine. Let’s say your savings are ₹1000 every month. Then at the end of the year you would have around ₹12100. What? 1000*12=12000. So where did the extra ₹100 come from?
The extra ₹100 came from the bank. Yes, the bank. How? Well, the bank has an idea called interest. Basically, you deposit money in the bank. The bank sets an interest rate, let’s say 10% annually. What this means is that every year the bank will add 10% of your money every year. So from 100% of saving you would have 110% savings. Of course, just like all other topics, interest has two types: Simple and Compound. Both of these are very easy to understand. Simple interest is adding a fixed amount of money every year. If your interest rate is 10%, you would get 10% of your initial savings every year. Didn’t understand? Let’s say you saved ₹1000. 10% of 1000 is 100. So you would get ₹100 added to your savings every year. So ₹1000 to ₹1100 to ₹1200 to ₹1300 and so on. Then there’s compound interest. Using the same example, compound interest gives 110% of the current money you have in the bank. So instead of ₹100 every year, you would get 10% of 1000, then 10% of 1100 then 10% of 1210 and so on. To calculate this you take your savings and multiply it by 110%. Do this three times and you’ve got your savings using compound interest for three years! Simple right?
Banks don’t only take money and give extra back. They also give out loans. Loans are the opposite of depositing. So the bank gives out money for people. Okay. They too have to pay interest. Okay. But then how do banks get money? Or can we just get a loan, deposit it into the bank, get interest, pay back the loan and gain extra money? Well, the answer for the first question is ……… they just put a higher interest rate for loans. If you get ₹8 out of ₹100 every year, you pay ₹10 out of ₹100. That extra ₹2 is their salary, or what they get to keep. Before you say ₹2? That is so less. What will they do with that?, remember that banks give out trillions and trillions of rupees every day so they get lots of money. That’s how the answer to the second question(which was ‘no’ by the way) is justified.
But how do banks get the money to loan that much money? Banks don’t just let your money rot in the lockers. They keep some amount, usually 10% of your money and loan the rest. That method of banking is called Fractional Reserve Banking(FRB). FRB is opposed by many(they call it cheating and manipulating) but it can not be phased out until a new or better way of banking appears. So, I guess that’s how the story goes.
So, interest, loans, and FRB. Anything else about banks? Well, actually, yes! Banks have many other jobs and interesting things, and this is just the tip of the iceberg. Even the device you are reading this on is connected to banks and finance. The huge topics of banks and finance are very vast, and very fascinating. So, go out there and find out other things instead of being stuck to your device!
By: Advith Reddy Chintala
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