Kembara's Financial Solutions - The Function of Banks
Banks have historically served as an easy conduit between savers and borrowers, profiting from the discrepancy between what they pay savers and what they charge borrowers. The bank is willing to offer interest—say, 5% per year—for the surplus funds that the depositors deposit there. The bank will then lend the deposited funds to borrowers, possibly at an interest rate of 8% annually. Therefore, if a bank received deposits totaling £100 million, it would have to pay £5 million in interest over the course of the year (5% x £100 million). If the bank was successful in lending the $100 million, interest payments would total £8 million for the entire year (8% x $100 million). The bank is making a £3 million profit because it is earning £8 million in interest while only paying out £5 million in interest. This is not a profit; rather, it is a surplus that must be used to cover costs like employee salaries, office rent, and taxes. Profit is what remains after deducting these expenses.
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