Banks and you: lending and deposit basics

The benefits of banks


Banks are vital in helping you achieve your financial goals. For one, they provide a safe place to keep your cash. Most bank deposits are insured by local financial authorities up to a certain level, which means there’s less risk of losing your money should the bank suffer financial distress. But as well as checking and savings accounts, banks also provide loans – whether you’re looking to make a large purchase or simply satisfy a short-term need for cash.


How interest rates work


Banks aim to make money by taking their customers’ deposits and lending them out as loans. The interest rate charged on loans is greater than that paid on deposits in order to account for the additional credit risks banks take on. 

Ultimately, however, the underlying interest rate in any given economy – the “base rate” banks charge when lending excess reserves out to each other overnight – is controlled by that economy’s central bank. In the US, this is called the “Federal Funds Rate” and is determined by the Federal Reserve System. Changes made to the base rate in pursuit of monetary policy goals will in turn influence the rates banks offer customers on loans and deposits.

A lower base rate, for example, reduces the cost of borrowing, helping to stimulate economic growth and inflation. Conversely, the central bank might raise the base rate to help combat inflation and moderate economic activity: borrowing becomes more expensive and consumers are encouraged to save with higher interest rates available on deposits.

Of course, the interest rate charged on loans or received on deposits will differ from person to person. Your credit score, loan size, and prior relationship with the bank will influence your individual cost of credit, while the interest rate you receive on deposits will be influenced by factors including your deposit currency, size, and duration.          


How borrowing works1


Credit occupies a central role in almost everyone’s financial universe. Since borrowing comes with a cost, however, the traditional approach is to use credit to pay for items that should grow in value over time. 

There are many different types of loans out there. Secured loans, such as mortgages, charge a lower interest rate than unsecured borrowing, but require you to put up collateral which can be seized and sold off to satisfy your debt in the event you can’t make interest payments or repay the principal. Installment loans are often used to finance specific purchases, requiring you to make steady (typically monthly) payments over a set period of time. “Revolving” loans like credit cards, meanwhile, command a higher interest rate – but allow you free and varied use of the funds.

The true cost of credit will ultimately depend on a loan’s structure, size, fees, interest rate, borrowing term, and frequency of required repayments. 


Optimizing your banking opportunities


There are several strategies you might consider using to maximize the interest return on your deposits while maintaining liquidity.

Certificates of deposit or time deposits (a.k.a. term deposits), for example, allow you to earn a fixed interest rate over a set period of time. You can use these strategically by locking in a higher interest rate if you anticipate rates will fall. They work best if you’ve got a predictable budget and can set aside funds you won’t need in the short term. 

In a declining interest rate environment, consider refinancing any existing debt to a lower interest rate. Taking on inexpensive credit may be sensible if you’re confident your money can be more profitably invested elsewhere.

In a rising interest rate environment, on the other hand, you may want to reduce debt and shift excess cash into higher-yielding savings accounts. Having access to a readily available revolving line of credit will also allow you to maintain flexibility, bargaining power, and liquidity without taking on the cost of excess debt.




Banks make money by lending out your deposits at a higher rate of interest than they offer savers.

Whatever type of credit you choose to use, your cost of borrowing will depend on the loan’s size, rate, and duration.

In a low-interest-rate environment, it may be worth taking on new credit to invest in assets which should grow in value over time.