What happens to money after you deposit it?

What happens to a $10 bill after you deposit it in your savings account? Does the bank teller
take it to a vault and put it into a separate compartment or cubbyhole marked with your name
and account number? No.

The bank begins by adding $10 to the amount that is already in your account (your existing
balance). Your $10 deposit and your new balance are then recorded in your bank book and
in the bank’s computer system. The $10 bill you deposited is mixed in with all the other cash
your bank receives that day.

When you and other customers deposit money in a bank, the bank “puts most of it to work.”
Part of the money is set aside and held in reserve, but much of the rest is loaned to people
who need to borrow money in order to buy a house or a car, expand a business, buy farm
equipment, or do any of the other things that require people to borrow money.

Of course, banks do not lend money just to provide a service. They do it to make money.
Here’s how it works. When you keep your savings in a bank, the bank pays you extra money, which is called interest.

The interest is added to your account on a regular basis, usually once a month.
Let’s say a bank pays its depositors interest of 3 percent a year on their savings. In simple terms,
that means if you keep $100 in your savings account, the bank will add $3 to your account
balance during the course of a year.

But, there is another side to interest. When someone borrows money from a bank, the bank
charges interest, and it charges borrowers a higher rate than it pays savers. For example, it
might pay savers 3 percent and charge borrowers 8 percent. The difference, 8 percent minus
3 percent, goes to the bank. Charging interest on loans is one of the main ways for a bank to
make money.

The rate of interest a bank charges depends largely on two things:

• how many people want to borrow money, and


• how much money banks have available to lend.

If a bank has plenty of money to lend, and the demand to borrow money is not particularly
strong, interest rates will tend to be low in order to attract borrowers. But when banks have
a smaller amount of money to lend, and the demand to borrow is fairly strong, interest rates
will rise. As a depositor, you want interest rates to be high, but as a borrower, you want them
to be low.

When it comes to paying interest on savings deposits, there usually isn’t a big difference
between banks. They pay just enough to stay competitive with one another and attract
depositors. So, if one bank is offering a much better (higher) rate than most other banks,
try to find out why. And remember the old saying: If something sounds too good to be true, it
probably is.

As a depositor, you want interest rates to be high, but as a borrower,
you want them to be low.

Source from : http://www.bos.frb.org