Mommy, how do banks work?

My Bank of America savings account earns me 0.25% interest, which I kinda thought was strangely low, but haven’t really questioned until now. That’s because I saw an offer on TiVo to open up an ING Direct savings account with pretty much the same terms as my BofA one (i.e. no fees, no restrictions, etc.) except they pay 2.6%. One place pays 0.25% and another pays 2.6%. Head…exploding. I don’t understand why this disparity exists. Why would anyone in their right mind use BofA for personal savings with such piss poor interest rates? They’re high-end CD accounts with huge required balances, 5 year commitments, and monthly maintenance fees still provide a lower return. Can someone who understands these things please explain to me what I’m missing here?

4 replies on “Mommy, how do banks work?”

  1. ING direct is an online-only bank, so they save a lot of money by not having branches and numerous employees, etc.
    btw, CD stands for Certificate of Deposit, not Compact Disk, but you probably knew that

  2. Now you know Danny, when it comes to money matters you are supposed to discuss it with Grandma Lou.

  3. Banks provide three basic services.
    They provide a place for individuals and businesses to hold their money. These individuals and businesses, also known as depositors, put money in banks because it’s safer than keeping the money at home. Banks promise to return the money and even buy insurance to make sure that they can honor that promise. Banks also pay interest in order to persuade individuals and businesses to put money in the bank. Interest is sometimes called the price of money because it is what the bank has to pay to obtain the money from customers like you.
    Banks provide a way to move money around from person to person. If you have money in the bank you can transfer the money to other individuals and businesses when necessary. There are various ways to do this and you do not have to go to the bank and take the money out to give it to someone else. For example, you can write a check or make payments via computer. Thus, banks make paying for things much easier.
    Banks loan money to people and businesses. The depositors who put money in a bank do not want all of their money at the same time. So banks can use some of the money to help other people who want to borrow money to buy cars, furniture, houses and lots of other things. People pay interest to the bank when they borrow the money and promise to repay the loan on time. Did you know that bank credit cards are just another form of borrowing money from banks?
    Let’s put these three services together. Banks take in money from depositors. They hold on to some of the money so that the people (depositors) can withdraw money when they want to or can tell the bank to pay it to someone else. The rest of the money is available for loans to trustworthy borrowers who have a need for some extra money.
    So! How do banks make money?
    Remember that banks pay interest to depositors. (In a sense, depositors loan money to the bank.) Banks, in turn, loan the money to borrowers who pay interest to the bank.
    The average interest percentage rate that banks pay depositors is lower than the average interest percentage rate they receive from borrowers. This difference, called the spread, is used to pay bank employees, pay for the bank building, lights, heat, etc. and provide some profit for the owners of the bank.
    As you can see, the basics of banking aren’t all that complicated.

Comments are closed.