Your bank may pay interest for keeping money in an account. Why would it pay you? Because deposits are valuable funding for the bank’s wider business. It earns income from assets and services while meeting the cost of deposits, other funding and its operations.
The familiar explanation is that a bank pays savers one rate and charges borrowers a higher one. That captures an important source of revenue, but it leaves out risk, regulation and how modern bank money is created.
Two sides of the balance sheet
Your deposit is an asset to you: money the bank owes you. To the bank, it is a liability. Loans made by the bank are assets because borrowers owe it repayments. Banks can also hold securities and liquid assets.
Interest earned on loans and other interest-bearing assets, minus interest paid on deposits and other borrowing, contributes to net interest income. A positive difference is useful, but it is not the same as profit.
Staff, technology, premises, fraud prevention and other expenses must be paid. Some borrowers fail to repay. A loan charging a high interest rate can still lose money if its credit losses are large enough.
The bank is not a warehouse of labelled notes
Modern lending does not usually involve taking one customer’s exact bundle of banknotes and handing it to another. As the Bank of England explains, a bank making a loan typically creates a matching deposit in the borrower’s account.
When that borrower pays someone at another bank, however, the first bank must meet the resulting payment obligation. Funding and liquidity still matter. Attracting and retaining deposits helps a bank manage the overall position rather than giving it unlimited freedom to lend.
This is why two statements can both be true: lending creates deposits, and banks compete for deposit funding. They describe different parts of the balance-sheet and payment process, not mutually exclusive stories.
Why savings rates vary
A bank considers how much funding it needs, the rates available elsewhere, central-bank policy and the stability of different accounts. Money committed for a term may have different value to the bank from funds that can leave immediately.
Competition matters too. A bank wanting more deposits may offer a higher rate, while another with less need for additional funding may not. The rate offered to savers therefore reflects more than the headline rate charged on one particular loan.
Deposits are only one source of funding. Banks can also use other forms of borrowing and shareholders’ capital, each with different costs and roles.
Profit comes with obligations
Banks must manage the mismatch between customers wanting ready access to money and borrowers repaying over months or years. Liquid assets help meet payments; capital helps absorb losses. Regulation addresses these risks, though no banking system eliminates every possible failure.
Fees for services can provide another income stream. Their importance varies by bank and business model.
The deposit account is therefore part of a larger financial machine. Banks earn by providing credit, payments and other services at revenues that exceed their funding costs, operating expenses and losses—not simply by finding a guaranteed gap between two interest rates.