Loans and how banks earn

Banks lend money as loans for things like buying a house or vehicle, or paying for education. Businesses borrow to buy machines and raw materials, transport goods, or launch new products.

A loan is money borrowed from a bank or financial institution that must be repaid with interest later. Just as banks pay interest to savers, they charge interest to borrowers; after an agreed time, the borrower repays the loan plus interest.

So how does the bank itself earn? It pays a lower interest rate to depositors and charges a higher rate to borrowers. The difference is the bank's income.

An example. Anand deposits ₹200, and the bank pays him 2% interest. The bank lends that ₹200 to Shreya at 5%. Shreya repays ₹200 plus ₹10 interest (5% of 200) = ₹210. The bank pays Anand ₹4 (2% of 200) and keeps ₹6.

Three people are better off at once: Anand's idle money earned ₹4, Shreya got the money she needed, and the bank earned ₹6 for arranging it.

But banks keep some reserve money and do not lend out all their deposits. If they lent every rupee, they couldn't pay depositors who came to take their money out. (The Reserve Bank of India sets how much must be kept back.)

Before 2014, only about 15 crore Indians had bank accounts; most people used cash. The Pradhan Mantri Jan Dhan Yojana, launched in 2014, aimed to give every Indian, especially poorer people, a bank account with no minimum balance and no fees. Since then over 50 crore accounts have been opened — mostly by women.

Now people from all walks of life use banks. Farmers borrow to start a small business or expand farming. Workers get wages paid straight into their accounts, and good students get scholarships directly. Such direct transfers cut out middlemen and make sure money arrives on time.