How banks work

What banks do with your deposits. Banks keep only a small part of their deposits as cash: in India, about 5 per cent. This cash is for depositors who come to withdraw money on any given day.

Why a little cash is enough. On any one day, only some of a bank's many depositors come to withdraw cash. So the bank can manage with this small amount. (The book asks: what would happen if all depositors came for their money at the same time?)

Most deposits become loans. People need loans for all kinds of economic activity, and in large amounts. Banks use the major portion of their deposits to give loans to people who need them.

How banks earn. Banks charge borrowers a higher interest rate than they pay depositors. Example: if a bank pays depositors five rupees a year on every hundred, and charges borrowers ten, it keeps the difference. This difference is a bank's main source of income.

Banks connect two groups. On one side are depositors, who have extra money (surplus funds) and want it safe and earning interest. On the other side are borrowers, who need money for farming, business or houses. Banks link them: money flows in from depositors and out to borrowers, and comes back with interest.