What happens to your money once you have deposited it with the bank?

Money in the bank It could be in the form of numbers on a screen or rectangle stacks green paper in a vault. The same reason why people have put their money in the bank for security for centuries is the same. 

Explore: GOBankingRates’ Best Banks of 2023
How to: Protect Your Financial Future With Gold and Silver
Student loans: DOJ Says Overruling Biden’s Forgiveness Could Lead to Lawsuits Over ‘Virtually All Federal Action’

Although they’re obvious targets for robbers, banks are highly secure and, in the modern era, highly insured. Bankers will also pay you a small interest for the privilege they have of holding your cash. According to CNBC, the average annual percentage yield for a savings account is 0.24%. That’s $1200 per year for a $5,000 deposit. Banks borrow money from their customers for dirt cheap — have you ever landed a loan for 0.24% interest? What do they do with the cash they receive as deposits, though? Well, it’s complicated. 

How can banks make money?

Your deposits are just a small part of the game. The Corporate Finance Institute says that even though modern banks have become complex, multi-faceted, and large, they still manage to make the most of their money through three methods.

• Interest income The interest payments made by borrowers to pay back loans make banks a profit. This is where your cash deposits come in — but not in the way you probably think.

• Capital markets income By providing services such as brokerage, underwriting, and merger and acquisition advisory services, banks make money on capital markets.

• Fee-based income: Banks also make money by charging a variety of fees — many of which you know and hate — associated with their services and products, including checking and savings accounts, credit cards, mutual fund revenues, custodian fees and investment management fees. 

Take Our Survey: How Do You Think the Economy Will Perform in 2023?

The Revolving Money Myth: Your Deposits Don’t Fund Bank Loans

According to common mythology, banks lend money to borrowers in return for customers’ deposits. The bank pays the lowest interest on deposits, charges higher interest rates for loans and pocketed the difference as a handsome profit. Banks act as intermediaries between savers looking to make a return on excess capital and borrowers willing to borrow.

In painfully simplified terms, that’s sort of true, but only in the most indirect of ways. 

The Money they Lend is Created by Banks

Banks don’t need your money to extend loans. The loans create new wealth.

Double-entry accounting requires that every bank making a loan creates a new account and makes a deposit equal the amount of the loan amount. 

Forbes states that banks create money when they lend money. They’re able to do this because banks are allowed to lend much more money than they have.

The Money They Lend Isn’t Really There

Banks use a fractional reserve system, which allows them only to withdraw cash reserves from a fraction of the money that they lend. A 1913 Federal Reserve Act mandates that banks maintain minimum cash reserves to clear outgoing check.

One of the cheapest ways to meet those reserve requirements, according to Resilience, a program under the Post Carbon Institute, is through “retail deposits” — that’s the money you keep in your savings account. If they can’t attract new customers to borrow cheap retail deposits from, banks have to meet their cash reserve requirements by paying more to borrow wholesale deposits from the Fed. 

In short, banks don’t take the money that you deposit, turn around and loan it at a higher interest rate. They do however use the money that you deposit to balance their books, meet cash reserves and make these loans possible.

More from GOBankingRates

This article first appeared on GOBankingRates.com: What Do Banks Do With Your Money After You Deposit It?