Have you ever wondered how banks make money and what happens to your savings when you deposit them? Let's peel back the curtain on the banking system and understand the dynamics of savings accounts and loans.

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The Basics of Banking

When you deposit money into a savings account, the bank doesn't just let it sit there. Instead, it uses your funds to provide loans to other customers. In return, the bank pays you interest on your deposit. However, the interest rate you receive is typically much lower than what the bank charges for loans. This difference is one of the ways banks earn profits.

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A Tale of Two Transactions

Imagine you have $10,000 and decide to deposit it into a savings account. The bank happily accepts your money, promising to pay you 2% interest annually. On the other side, someone else needs a loan of $10,000. The bank lends your deposited money to this person at a 10% interest rate.

After a year, you return to the bank to check on your savings. You've earned $200 in interest (2% of $10,000). Meanwhile, the borrower repays the loan with $1,000 in interest (10% of $10,000). The bank has made a profit of $800 ($1,000 from the borrower minus $200 paid to you).

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Understanding the System

This scenario highlights the fundamental working principle of traditional banking. Banks use the money deposited by savers to lend to borrowers, charging a higher interest rate for loans than they pay for deposits. This difference, known as the spread, is a key source of income for banks.

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In conclusion, understanding how banks operate can help you make more informed decisions about where to keep your money and how to grow it. While the interest on savings accounts may be low, they offer security and liquidity. For those looking to potentially earn higher returns, exploring other investment options might be the way forward.

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