An Introduction To Banking
The primary function of a bank has not really evolved since the first banks and bank accounts came into existence. Banks offer two primary functions. First they allow deposits to be made into a bank account. These have evolved into current accounts and savings accounts. We look at the difference between current accounts and savings accounts below.
Second, banks advance credit in the form of a loan. A loan is where credit is advanced and repayment terms are agreed at the outset. This is then called a loan from the bank to the customer. Other customers wanted a place to deposit their money but did not require easy and quick access to the money they deposited with the bank.
As the number of banks has grown over time so have the terms on which they offer banking accounts or loans changed. When banks first started to operate there was no distinction between a savings account and a current account. There was just simply one type of account known as a deposit account. As competition between banks grew so the services they offered had to develop. It became clear early in the history of banking that customers had different requirements for their deposit accounts.
Some customers would prefer a deposit account that did not offer them such easy and fast access to their money but instead offered them an incentive to leave their money in the bank account for long periods of time.
This then led o the establishment of current accounts for those customers that wanted easy access to their money and to savings accounts for those customers that did not require easy or fast access to the money they had deposited in the bank account.
Banks started to make money by encouraging customers to deposit money with them and then lending this money out to other customers. Banks pay less interest on the money that is deposited with them in accounts than on money that they loaned out to customers. This is how banks established that they could make profits from their activities.
But in order to have enough money to loan out banks had to encourage many people away from current accounts and towards savings accounts. The way they found to do this was to offer attractive financial incentives to those who could leave their money in a savings account. Imagine if every bank customer took all of his or her money out at the same time, the bank would obviously not then be in a position to loan any money out.
If you decide to deposit your money in a savings account then the bank will generally pay you a higher rate of interest than if you choose to have a current account with the bank.
The position is similar with loans. The longer the period of time over which you want to borrow money from a bank then generally the lower the rate of interest that you would have to pay to the bank on the amount of the money that you have borrowed.
Banks generally pay and collect interest on a compound basis. This is where the interest that the bank pays on the money you have in your bank account is added to the money in the account and then interest is next paid on both the amount that started in the bank account and the interest that has already been paid, and this continues on and on.
The position is the same where you borrow money from the bank using a loan. It is for this reason that people sometimes get themselves into trouble when borrowing money. If the interest rate is high and is compounded then the amount of the loan can often grow very quickly without the customer actually borrowing any more money from the bank.
As time developed current accounts and savings accounts began to diversify themselves and there is now a wide variety of different types of current accounts and savings accounts that have developed to take account of the ever diversifying needs of the banks customers. In our article entitled “Types of Current accounts” and our article “Types of Savings Accounts” we take a closer look at the types of account that are now offered by the bank.
Short term and long-term loans have evolved to meet developing and ever changing customer needs. We have many further articles on loans, which we hope that you will enjoy reading.