How Banks Make Money: The Spread Between Deposits and Loans

You already know that saving lets your money earn interest. But where does that interest come from — and what does the bank do with your cash after you hand it over? The answer is the engine at the heart of banking: banks take in deposits and turn around to make loans.

When you put $1,000 in a savings account, the bank doesn't lock it in a vault. It lends most of it to other people — a mortgage for a homebuyer, a car loan, a small-business line of credit. This is called financial intermediation: the bank sits in the middle, gathering money from savers and channeling it to borrowers who need it.

Banks profit from the gap between two interest rates, known as the net interest spread. Suppose the bank pays you 2% on your deposit but charges a borrower 6% on a loan. That 4% difference is the bank's revenue for connecting the two of you and taking on the risk. Multiply a small spread across millions of accounts and loans, and it adds up.

Banks don't lend out every dollar, though. They keep a portion on hand — reserves — so that everyday depositors can withdraw cash whenever they want. Balancing profitable lending against the need to keep enough cash available is the core job of running a bank.