how do banks work ?

it is mandatory for all banks to have a banking license.

typically you deposit your money into a bank . it pays you some interest for it.

now they take your money and lend it to other people or companies at a higher rate of interest. The difference between the interest rate they lend out and the interest rate they pay you is how they make profit . It’s that simple.

This method is called fractional reserve banking system. Typically , there is a factor – this is the multiplication factor . So if they have a deposit of x, they can lend 10 x or 20 x , based on the factor called leverage.

if a company or a lender defaults on the loan / cannot pay back , it is recorded in the bank’s balance sheet as a non performance asset ( NPA ) . Too many NPA ‘s will make the balance sheet weak .

Every bank has to work with the central reserve bank of the country and keep a certain part of the money as a deposit with them ( the exact amount or percentage is defined by the central bank) . It is called the cash reserve ratio.

Here is an interesting video from a governmental hearing .

Governmental Hearing

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