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The Business Of Banking - How Banks Use Our Money

By Edited Sep 24, 2015 0 0

Bank loans and investments

Learning things about the banking system

A bank does not keep every dollar deposited in it. Such idle money would be of value neither to the bank nor its customers. Bankers know  from experience that they need hold only a small fraction of their customers' money in the bank building.

Assume that a bank receives $10,000 in deposits in one day. Experience tells the banker there is little chance that all of it will be withdrawn within the near future. So he uses most of the $10,000 to makes loans and investments. He keeps a small fraction of it as cash available for withdrawals.

Bank deposits that are not used to make loans are invested. Investments are also called securities. United States government  bonds are generally a bank's largest investment. They are very safe and can be sold easily when money is needed. Some state banks are allowed by law to invest in stocks. National banks cannot.

"Runs" (sudden and numerous withdrawals) were once common in times of financial panic when depositors feared for the safety of their money. Today runs seldom occur. Banks are nevertheless required by law to keep a reserve against possible calamity. The reserve is a percentage of the total amount deposited in a bank. The legal percentage changes from time to time and it also varies with the location of the bank. Large city banks, for example, are required to maintain a larger reserve than small-town banks. The reserve us usually represented by deposits carried in another bank. Part of the reserve may be cash on hand or government securities.

When a bank lends money to a person, it is trusting that person to pay it back. In other words, it is giving him credit for his honesty and his ability to return the money. Banks deal in commercial, consumer, and agricultural credit.

Loans are based on promissory notes or in collateral. A promissory note is simple a signed agreement by the borrower that he will pay back the money within a certain time at a certain interest rate. A collateral loan, or secured loan, is one in which the borrower turns over security (property) to the bank. He also signs a promissory note. The bank holds a lien on the security until the loan is paid.

Commercial credit means the loaning of money to businesses. It is usually extended as a short-term loan. The business concern promises to pay it back in a relatively short period of time, usually 30 days to six months. An intermediate-term loan is generally repaid in from two to eight years.

Consumer credit consists of a personal laon or an installment loan made to an individual. A personal loan generally involves a small amount of money and is usually secured by a promissory note. An installment loan involves a large sum of money and is generally secured by property. A real-estate loan is secured by a mortgage on the real estate and is repaid in installments.

Agricultural credit is extended to farmers who need money to operate their farms until harvest time. The loan is usually for a short term and is secured by a promissory note either with or without property.

Each loan granted by a bank means, of course, that a debt has been created for the borrower. It has been made by extending credit; that is, by accepting the promise of the borrower that he will pay it back. It is the responsibility of the bank to make loans that can and will be repaid.

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