Banks are businesses that help people store money safely, make payments, borrow funds, and earn interest. They matter because most households and businesses use banks to manage everyday financial decisions. A bank connects savers who deposit money with borrowers who need money for homes, education, equipment, or starting a business.
Understanding banks helps students make smarter choices about saving, borrowing, and planning for the future.
A bank works like a money-flow machine by taking deposits, keeping some cash in reserve, and lending the rest to qualified borrowers. Borrowers pay interest on loans, and banks use part of that income to pay interest to depositors and cover operating costs. Banks also study risk using data, credit history, and statistics so they can decide who is likely to repay a loan.
When banks lend responsibly, money moves through the wider economy and can support jobs, purchases, and business growth.
Key Facts
- Deposit balance after simple interest: A = P(1 + rt)
- Loan interest for one year: I = Prt
- Bank profit from lending is partly based on spread: interest rate charged on loans minus interest rate paid on deposits
- Reserve ratio formula: reserve ratio = reserves ÷ deposits
- If a bank has 100,000 in reserve
- Credit decisions often compare risk, income, debt, collateral, and repayment history
Vocabulary
- Deposit
- A deposit is money a customer places in a bank account for safekeeping and possible interest earnings.
- Loan
- A loan is money borrowed from a bank that must be repaid, usually with interest.
- Interest
- Interest is the cost of borrowing money or the reward for saving money, usually shown as a percentage.
- Reserve
- A reserve is the portion of deposits a bank keeps available instead of lending out.
- Credit risk
- Credit risk is the chance that a borrower will not repay a loan as promised.
Common Mistakes to Avoid
- Thinking banks keep every deposited dollar in a vault is wrong because banks usually keep only a portion in reserve and lend the rest to borrowers.
- Ignoring the interest rate on a loan is wrong because even a small rate difference can make the total repayment much larger over time.
- Confusing debit cards with credit cards is wrong because a debit card spends money from an account, while a credit card creates a short-term loan that must be repaid.
- Assuming every loan is approved automatically is wrong because banks evaluate income, credit history, debt, collateral, and risk before lending.
Practice Questions
- 1 A student deposits $500 in a savings account with simple interest at 4% per year. How much money will be in the account after 3 years using A = P(1 + rt)?
- 2 A bank has $250,000 in deposits and must keep a 12% reserve ratio. How much must it keep in reserve, and how much could it potentially lend out?
- 3 A small business owner wants a loan to buy equipment, but their income changes a lot from month to month. Explain two reasons a bank might see this loan as risky and one thing the owner could do to improve the application.