Understanding How Commercial Banks Repay Loans

When a bank creates a loan, it also creates a verifiable deposit of the same amount. Banks make money from the interest they earn by lending money to other customers. The funds they lend come from customer deposits, but the interest rate paid by the bank on the money it borrows is lower than the rate applied to the money it lends. For instance, a bank may offer savings account customers an annual interest rate of 0.25%, while charging mortgage customers 4.75% annual interest.

The process of creating money can also work in reverse. When you withdraw cash from your bank, you reduce the bank's reserves. Just as a deposit at Acme Bank increases the supply of money by a multiple of the original deposit, your withdrawal reduces the supply of money by a multiple of the amount you withdraw. And just as money is created when banks issue loans, it is destroyed as loans are returned.

Repaying a loan reduces provable deposits; therefore, it reduces the supply of money. Washington Mutual, a savings and loan company based in Washington State, was a relatively small institution whose CEO, Kerry K. With the interest they earn on their loans, banks can pay interest to their depositors, cover their own operating costs and make profits, while at the same time maintain the ability of the original depositors to spend the funds whenever they want. Borrowing from another bank is usually the cheapest option, but many commercial banks, especially when they only apply for a one-day loan to meet reserve requirements, choose to borrow from the discount window because of its simplicity. When a bank's excess reserves equals zero, it is lent when a bank's excess reserves equals zero. Commercial banks provide various services to individuals and small businesses.

These services include checking and savings accounts, loans and mortgages, basic investment services such as CDs, as well as other services such as safe deposit boxes. In an effort to avoid a similar fate, several other investment banks applied for the status of ordinary commercial banks subject to the strict regulation faced by those institutions. Investment banks that had made substantial purchases of securities whose value was ultimately based on those mortgage loans began to go bankrupt. Note that when banks received new deposits, they could make new loans only up to the amount of their surplus reserves, not up to the amount of their deposits and the total increase in reserves. Mortgages are used to buy property and houses are usually used as collateral that guarantees the loan. The term commercial bank refers to a financial institution that accepts deposits, offers current account services, provides various loans and offers basic financial products such as CDs and savings accounts to individuals and small businesses. This allows banks to grant new loans of up to (usually) 90% of their available deposits, theoretically growing the economy by freeing up capital for loans.

These functions define a financial intermediary bank that accepts deposits, grants loans and offers current accounts. In addition, depositors may not analyze banks' lending activities as carefully as they would if they considered that reckless lending could result in the loss of their deposits since their deposits are insured. Washington Mutual aggressively extended credit to low-income individuals and families for credit cards, car loans and mortgages.

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