What Do Banks Do With the Money You Deposit?

When you deposit money into a bank, it becomes an active part of the broader financial system. Banks serve a fundamental role as intermediaries, connecting individuals and businesses with surplus funds to those needing capital. Your deposited money does not simply sit idle in a vault; instead, it is strategically deployed to facilitate economic activity.

Using Deposits for Lending

A primary function of banks is to use deposited funds for lending, which supports various financial needs across the economy. Banks operate under fractional reserve banking, meaning a fraction of deposits is kept in reserve, while the remainder is available for loans.

Banks provide various types of loans. Mortgages are common, enabling individuals to purchase homes. Businesses rely on bank loans to fund operations, expand facilities, or invest in new projects. Consumer needs are met through personal loans for various expenses and credit cards, offering revolving lines of credit for everyday purchases.

The main way banks generate revenue from these activities is through interest income. Banks charge borrowers a higher interest rate on loans than they pay to depositors; this difference, known as the net interest margin, covers operational costs and generates profit. For example, if a bank pays 0.5% interest on a savings account but charges 6% on a car loan, the spread contributes to its earnings.

Using Deposits for Investments and Operations

Beyond direct lending, banks utilize deposited funds for various investments and to cover their operational expenses. A portion of deposits is strategically invested in relatively low-risk financial instruments, such as government securities like Treasury bonds, to generate additional income and maintain liquidity. Banks may also invest in certain corporate securities, though these are more regulated due to their higher risk.

Banks are also required to maintain reserves, which are funds held either physically in their vaults or as balances at a central bank. While the Federal Reserve adjusted reserve requirements to zero, banks still hold reserves. These holdings ensure banks have sufficient cash to meet daily withdrawal demands and manage unexpected liquidity needs. Any reserves held above regulatory minimums or prudent internal targets are known as excess reserves, which can be used for further lending or investment.

A significant portion of deposited funds is allocated to cover the bank’s daily operational costs. These expenses include salaries for employees, maintenance of physical branch locations, and investments in technology infrastructure. Funds are also used for marketing and other administrative overhead necessary to run the institution.

Banks also engage in interbank lending, where they lend money to and borrow from other financial institutions. These transactions help banks manage their short-term liquidity needs, ensuring they always have enough cash on hand. Deposits serve as the underlying capital that facilitates these interbank exchanges.

Managing Risk and Protecting Deposits

Protecting customer funds is a primary responsibility for banks, and several mechanisms are in place to manage risks and safeguard deposits. One prominent protection in the United States is deposit insurance provided by the Federal Deposit Insurance Corporation (FDIC). The FDIC insures deposits up to $250,000 per depositor, per FDIC-insured bank, for each account ownership category.

Banks are also subject to capital requirements, which mandate that they hold a certain amount of their own capital as a buffer against potential losses. This capital, which includes equity, acts as a financial cushion, absorbing unexpected losses from loans or investments. These requirements are designed to ensure banks remain financially sound and can withstand adverse economic conditions.

Effective liquidity management is another important aspect of protecting deposits. Banks actively manage their assets and liabilities to ensure they can meet customer withdrawal requests at all times. This involves holding sufficient cash reserves and having access to diverse funding sources. Banks also conduct stress tests to evaluate their ability to handle various hypothetical scenarios, such as sudden increases in withdrawals, ensuring they can maintain adequate cash flow.

Furthermore, banks operate under extensive regulatory oversight by various government bodies. Agencies like the Federal Reserve, the FDIC, and the Office of the Comptroller of the Currency (OCC) supervise banks to ensure they operate safely and adhere to established rules. These regulations encompass areas such as consumer protection and anti-money laundering measures.