A bank can become more profitable by using a percentage of its deposits to lend to other customers. If a bank pays 2% on bank deposits but lends money to firms and consumers at 6%, then it can make a bigger profit on its deposits. A bank just needs to keep sufficient liquidity to meet the demands of customers to withdraw money.
Different types of bank lending
Different interest rates on different types of loans.
Bank lending varies from unsecured personal loans to secured mortgage lending. Unsecured lending tends to be at a higher interest rate because of the risk factor. Secured mortgage lending is at a lower rate, but can be over 30 years or more.
- Personal loan – In this case, the bank may make a loan to be paid back over a few years. This loan may be unsecured against any assets like a house. Personal loans could be for a big purchase like a car or specifically to help fund a career or educational improvement.
- Business loan – A loan for a firm to invest and expand their business.
- Mortgage – This is a special type of loan, where the bank advances a loan to purchase a house. Usually, the customer will need to pay a deposit on the house, e.g. 10% of the loan. The bank legally owns the house until the borrowers have finished paying back the mortgage payments over a period of 20-40 years. Interest rates on mortgages tend to be relatively low because the loan is secured against the value of the house. However, on a 30-year mortgages, home-buyers will typically pay more interest than the total cost of the house.
- Overdraft. A bank can agree on an overdraft with customers. This allows them to borrow money in the short term quickly and conveniently. However, the amount allowed tends to be quite small.