Even though I study economics, I didn’t fully understand how banks made money until I came across the explanation in my Macroeconomics textbook last year.
It’s a misunderstood but important force to understand.
When you hear something like “the government is raising the interest rate,” the effects of that can quickly trickle into your everyday banking life. It can affect how much you pay on something like a car loan, and it’s all based around banks ensuring they’re making income.
As a kid, I only saw the side of my bank that dealt with chequing and savings accounts and debit cards. I couldn’t figure out why these banks were in business, because all they did was store my money.
Banks perform a lot more functions than simply chequing accounts. Depositing and storing money is only a part of the bank umbrella—a cog in a large, money-making machine.
To boil it down, banks make their money from lending out money—like the money 10-year-old me deposited into an account—at an interest rate to those who want it.
Essentially, like any other business, a bank sells a product. That product is the loaned-out money, and its “price” is the interest rate it’s lent at.
Getting a low interest rate is better than a high one because it means you’re getting your product—money—at a cheaper price, since a lower interest rate means the money you owe back in the end is multiplied by a smaller number.
Mortgages, loans, credit cards—these are all different “products” that run on the same fundamental principle of lending out money at a price. That’s all there really is to it.
If you were ahead of me and already knew the intricate workings of a bank, let me just leave you with this: a bank is a business, and they want to make money off you. So when you go to buy a new car, make sure you get the lowest interest rate possible.
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