What Do Banks Do With Your Money When You Deposit It?

Banks serve a fundamental role as financial intermediaries, connecting those with surplus funds to those who require capital. When individuals or businesses place money into a bank account, these deposits do not simply remain idle in a vault. Instead, these funds become an active component of the banking system, which is designed to facilitate economic activity. Deposits fuel a bank’s operations, transforming savings into circulating capital that benefits depositors and the broader economy.

Funding Loans and Credit

A primary function of banks involves utilizing deposited funds to extend various forms of loans and credit. Customer deposits form a significant pool of capital that banks then lend to individuals, families, and businesses. This lending activity includes common offerings such as home mortgages, which often have repayment terms ranging from 15 to 30 years, and typically require a down payment between 3% and 20% of the purchase price. Additionally, banks provide personal loans that borrowers can use for diverse purposes, with repayment periods generally spanning one to seven years.

Beyond individual consumers, banks also offer auto loans for vehicle purchases and a variety of business loans. These business loans might include working capital lines of credit for day-to-day operational needs or longer-term commercial loans often secured by real estate or major equipment. This lending stimulates economic growth by providing capital for individuals to make purchases and for businesses to invest, expand, and create employment.

Banks generate a substantial portion of their revenue by charging interest on the loans they issue. The interest rates on loans are typically higher than the interest rates paid to depositors, creating a net interest margin that covers the bank’s operational costs and contributes to its profitability. This allows banks to sustain operations and provide credit services.

Bank Investments and Liquidity

Beyond direct lending, banks allocate a portion of their deposited funds to strategic investments and the maintenance of liquidity. Banks invest in various financial instruments, primarily low-risk securities such as government bonds, including U.S. Treasury bonds, notes, and bills. These investments provide an additional source of income for the bank while generally carrying minimal risk due to the backing of the federal government. Some banks may also invest in corporate bonds or, less commonly and under strict regulation, in equities, though these typically involve higher risk.

Maintaining sufficient liquidity is important for banks to operate effectively and meet financial obligations. Liquidity refers to a bank’s ability to fulfill customer withdrawal demands and other short-term financial commitments promptly. Banks hold liquid assets, such as cash reserves and readily marketable securities, to ensure they can manage these outflows without disruption.

Interbank lending also plays a role in a bank’s liquidity management, where banks lend funds to each other on a short-term basis. This practice helps individual institutions meet immediate liquidity needs and facilitates the efficient allocation of capital across the broader financial system.

Operational Capital and Reserve Compliance

A segment of deposited funds supports a bank’s internal operations and ensures compliance with regulatory mandates. Banks allocate deposits to cover day-to-day operational expenses. These costs include employee salaries and benefits, maintaining physical branch locations, and investing in technology infrastructure, cybersecurity measures, and administrative functions. Personnel costs alone can account for a significant percentage of operating expenses, often ranging from 30% to 40% of the total overhead.

In addition to operational expenses, banks must also adhere to reserve requirements, which were historically set by central banks like the Federal Reserve in the U.S. These requirements traditionally mandated that banks hold a certain percentage of their deposits as reserves, either in their vaults or at the central bank. These reserves were not intended for lending but rather to ensure the bank possessed sufficient funds to manage potential short-term needs and contribute to overall financial stability.

While the Federal Reserve reduced reserve requirement ratios to zero percent effective March 26, 2020, banks still maintain reserves for various reasons. These include managing liquidity, meeting internal risk management policies, and complying with other capital adequacy regulations.

Protecting Deposited Funds

The safety and security of customer deposits are safeguarded through robust mechanisms within the financial system. The Federal Deposit Insurance Corporation (FDIC), an independent agency of the U.S. government, plays a central role by insuring deposits at FDIC-insured banks. This insurance provides coverage up to $250,000 per depositor, per insured bank, for each account ownership category. This means that funds in checking accounts, savings accounts, money market deposit accounts, and certificates of deposit are protected.

Coverage is automatic for accounts at FDIC-insured institutions, and depositors do not need to apply for it. The FDIC’s insurance is backed by the full faith and credit of the United States government, providing a high level of assurance to depositors. Since the FDIC’s establishment in 1933, no depositor has lost a single penny of FDIC-insured funds.

Beyond deposit insurance, other safeguards are in place to protect depositors’ money. These include capital requirements that ensure banks hold a certain level of equity relative to their assets, regular audits, and comprehensive regulatory oversight by federal agencies such as the Office of the Comptroller of the Currency (OCC) and the Federal Reserve System.