Safeguarding deposits. Deposits in a bank are relatively safe. Banks keep cash and other liquid assets available to meet withdrawals. Liquid assets include securities that can be readily converted to cash. Banks are also insured against losses from robberies. But the most important safeguard is the fact that in most countries, governments have established deposit insurance programs. The insurance protects people from losing their deposits if a bank fails.
A bank not only keeps savings safe but also helps them grow. Funds deposited in a savings account earn interest at a specified annual rate. Many banks also offer a special account for which they issue a document called a certificate of deposit (CD). Most CD accounts pay a higher rate of interest than regular savings accounts. However, the money must remain in the account for a certain period, such as one or two years, to earn the higher rate of interest. Banks also offer money market accounts. These accounts pay an interest rate based on the prevailing rates for short-term corporate and government securities.
Providing a means of payment. People who have funds in a bank checking account can pay bills by simply writing a check and mailing it. A check is a safe method of settling debts, and the canceled check provides proof of payment. Customers may also ask a bank to automatically pay recurring bills, such as telephone and mortgage payments, by a process called direct deposit deduction. Many banks allow people to pay bills electronically by telephone or through the Internet computer network.
Many banks offer credit cards. People can use the cards to pay for their purchases at stores and other businesses. The bank then pays the businesses directly and sends the customer a monthly bill for the amount charged. The cardholder can usually choose to pay only part of the bill immediately. If so, he or she must pay a finance charge on the unpaid balance.
Banks may also issue debit cards, which resemble credit cards. When a cardholder uses a debit card, the amount of the purchase is deducted directly from the cardholder’s checking account. Some cards can be used as either credit or debit cards.
Making loans. Banks receive funds from people who do not need them at the moment and lend them to those who do. For example, a couple may want to buy a house but have only part of the purchase price saved. If one or both of them have a good job and seem likely to repay a loan, a bank may lend them the additional money they need. To make the loan, the bank uses funds other people have deposited.
A major obligation of a bank is to permit depositors to withdraw their funds upon demand. But no bank has enough cash readily available to satisfy its depositors if all were to demand their funds at the same time. Banks know from experience, however, that such a demand–called a run–rarely occurs. If people are confident they can withdraw their funds at any time, they will leave them on deposit at the bank until needed. As a result, banks can loan and invest a large percentage of the funds deposited with them. In most countries, the government limits the percentage of a bank’s funds that can be used for loans and investment. The government simultaneously sets a minimum percentage that must be kept on reserve for meeting withdrawals.