Your turn
Each lab is one step from the video. Slide, tap and watch where the money goes.
Each lab isolates one idea. Balance sheet: OpenStax's textbook bank. Rates are round example numbers. Not financial advice.
Tap the pictures and slide the sliders.
Open the door. How much of the bank's money is sitting there as cash?
In the textbook bank only $2M of $11M is held as reserves; the rest is loans and bonds.
Tap to open the big safe. Is Nora's money inside?
Slide the rates. When is the gap biggest? What if savers get more than borrowers pay?
Net interest on $1,000 lent and $1,000 saved for a year: $1,000 × (loan rate − deposit rate). It must also cover costs and loan losses.
Slide them. Who gets a bit more, and what does the bank keep?
Example rates only, not today's rates.
Tap each fee. Who pays whom?
Account, cash-machine, overdraft (opt-in for ATM and one-time debit) and interchange fees are part of noninterest income: roughly a third of FDIC-insured banks' net operating revenue, 2010–2020.
How much can the bank lose before its cushion is gone?
Defaults cut assets; liabilities stay at $10M. Capital (net worth) absorbs the loss until it hits zero.
Slide it. When is the cushion all gone?
Slide how many savers want their cash, then switch on insurance. What changes?
The textbook bank holds $2M of cash for $10M of deposits. Insurance protects insured deposits, so most savers have no reason to run.
What if everyone wants their money? Then tap the button.
Can you stay profitable AND keep enough cash?
Trade the spread against liquidity and credit risk.
A toy model with example numbers: $1,000,000 of deposits for one year, $10,000 of costs, savers drift away if you pay under 1%. Not financial advice.
Nora takes her piggy bank money to the bank. The bank keeps it safe. But it doesn't just sit in a big safe!
Some people save money, like Nora. Other people need money now, like a baker who wants a new shop. The bank lends the saved money to the baker.
The bank gives Nora a tiny bit extra for letting it use her money. The baker pays the money back, plus a little more. The bank keeps the difference. That's how it earns money.
Sometimes a person can't pay back. So banks keep some of their own money as a cushion. And at insured banks, a government program protects people's savings up to a limit, so most people don't need to rush to get their money.
This page explains how banks work; it isn't financial advice. Interest rates in the examples are round numbers to make the math easy, not today's rates.
Banks mainly make money on the difference between the interest they pay savers and the interest they charge borrowers. That difference is called the spread. A bank might pay savers a low rate on their deposits and lend the same money to a family buying a house, a person buying a car or a business opening a shop at a higher rate.12
Banks also earn interest on the bonds they own, and they charge fees for services.1 Put together, a typical bank earns only a little over 1% of everything it owns each year, a figure called return on assets.1 Small slices on a very big pile of money add up.
It doesn't sit in a vault with your name on it. All deposits go into one big pool, and the bank lends most of that pool out or invests it.2 To the bank, your deposit is a liability: money it owes you and must pay back when you ask. Loans and bonds are its assets: things that will pay it money in the future.2
The OpenStax economics textbook uses a simple example bank:2
| What the bank owns (assets) | What the bank owes (liabilities) and its own capital | ||
|---|---|---|---|
| Loans | $5 million | Deposits from savers | $10 million |
| Government bonds | $4 million | Net worth (the bank's own capital) | $1 million |
| Reserves (cash) | $2 million | ||
| Total | $11 million | Total | $11 million |
Only $2 million of the $11 million is kept as cash and reserves. In the textbook, reserves are money the bank keeps on hand and doesn't lend or invest, so a bank keeps enough to handle everyday withdrawals and puts the rest to work.2 In the U.S., the Federal Reserve set its reserve requirement to zero in March 2020, but banks still hold reserves and cash.14
Lending even creates new money. When a bank makes a loan, it credits the borrower's account with money that didn't exist before: the loan creates a new deposit. Rules about capital limit how far banks can go.1516
A bank is a financial intermediary, a middleman between savers and borrowers.12 Here's the idea with simple example numbers:
| Example | Rate | On $1,000 for one year |
|---|---|---|
| Borrower pays the bank | 6% | $60 |
| Bank pays the saver | 1% | $10 |
| Spread (the bank keeps) | 5 points | $50 |
Across all of a bank's loans and deposits, this gap is measured as the net interest margin: what the bank earns on interest-earning assets minus what it pays on interest-bearing liabilities, divided by its interest-earning assets.4 The $50 isn't all profit, though. The bank still has to pay staff and rent, and cover loans that are never paid back.4 Real rates change all the time, and the math of interest growing on interest is in our explainer on how compound interest works.
Why don't banks just pay savers almost nothing? Because savers can move. If a bank pays much less than others, deposits flow to banks that pay more.2
Interest is the biggest source of income, but it's not the only one. Banks earn fees for customer services.1 Common ones:
How much do fees matter? For U.S. banks insured by the FDIC, "noninterest income" (fees and other services) was between about 31% and 39% of their net operating revenue from 2010 to 2020. That's roughly a third. Interest made up most of the rest.5 Credit cards add interest and fees of their own. See how credit cards work.
Lending is risky. A well-run bank expects a small share of borrowers not to repay and plans for it.2 The danger is when many more loans go bad than expected, which can happen in a recession.2
Look at the example bank again. Its cushion is the $1 million of capital (net worth): what it owns minus what it owes. If unexpected defaults shrink its loans from $5 million to $3 million, its assets fall to $9 million while it still owes savers $10 million. Its net worth is now negative, and it couldn't pay every saver back.2 That's why regulators require banks to keep a minimum amount of capital.3 Banks also spread their loans across many kinds of borrowers (homes, cars, different businesses) so one bad patch doesn't sink them.2
Banks have a timing problem. Savers can take their money out any day, but loans such as a 30-year home mortgage are paid back over years or decades.2 A bank keeps only part of its deposits as cash, so if lots of savers want their money at the same moment, the cash runs out.3
When depositors race to withdraw, that's a bank run. Even a rumor can start one, and a run can topple a healthy bank, because it can't call its loans back fast enough. Runs used to spread from one bank to the next.3
That's what happened in the U.S. in the early 1930s. Regional banking panics struck in 1930 and 1931,11 and thousands of banks failed in the three years before March 1933, when the president closed every bank for a national "bank holiday."12 The crisis also made the Great Depression worse. Prices were falling too; learn why prices usually rise in what causes inflation.
The Banking Act of 1933 created the Federal Deposit Insurance Corporation (FDIC) to insure bank deposits,13 and insurance began on January 1, 1934. Since then, no depositor has lost a penny of FDIC-insured funds.10 The FDIC is paid for by the premiums banks pay, not by money Congress sets aside.10
The standard coverage is $250,000 per depositor, per insured bank, for each account ownership category (such as single accounts, joint accounts and certain retirement accounts).9 It covers checking, savings, money market deposit accounts and CDs. It does not cover stocks, bonds, mutual funds, crypto or what's in a safe deposit box.9 Stocks are a different way of putting money to work, explained in how the stock market works.
Insurance calms the panic: if savers know their insured money is safe, they have much less reason to rush. Congress put two protections against bank runs in place: deposit insurance and the Federal Reserve lending to banks in an emergency (the "lender of last resort"). Savers with more than the insured amount can still have a reason to rush.3 About 70 countries, including all the major economies, had deposit insurance when the OpenStax textbook was written.3
Where does the money a bank earns go next? Part of its profit is paid in taxes, like any business's: see how taxes work.
Mostly by lending. A bank pays savers a low interest rate on deposits and charges borrowers a higher rate on loans. The gap, called the spread, has to cover the bank's costs (staff, buildings, loans that aren't repaid). What's left is profit. Banks also earn interest on bonds and charge fees for services.
1) The spread: the difference between the interest they pay on deposits and the interest they earn on loans. 2) Interest on securities they own, such as government bonds. 3) Fees for services, such as account fees, overdraft fees, ATM fees and a share of card fees paid by shops.
Interest. For U.S. banks insured by the FDIC, noninterest income (fees and other services) was roughly a third of their net operating revenue between 2010 and 2020, so net interest income from loans and securities made up most of the rest.
FDIC insurance covers up to $250,000 per depositor, per insured bank, for each account ownership category. Money above that in the same category at the same bank isn't covered by insurance. Deposits in different ownership categories (for example a single account and a joint account) are insured separately, and so are deposits at different insured banks. The FDIC's online estimator can show how much of a specific set of accounts is covered.
Yes. Deposits go into one big pool. The bank lends most of it out or invests it in bonds and keeps only part as cash and reserves. That's why a bank can pay you interest: borrowers pay the bank more than the bank pays you. Lending also creates new money: when a bank makes a loan, it puts new money into the borrower's account (Bank of England).
Money in checking accounts can be lent out or invested, and checking accounts often pay little or no interest. Banks can also earn from monthly account fees, overdraft fees, fees for using another bank's ATM, and a share of the fee shops pay each time you pay with your debit card.
If the bank is FDIC-insured, your deposits are protected up to the insurance limit. The FDIC often sells the failed bank's deposits and loans to another bank. Since insurance began on January 1, 1934, no depositor has lost a penny of FDIC-insured funds.