How do banks work?

Saving and borrowing

Every month Navdeep puts aside ₹3000 of his salary. Keeping it in a cupboard is risky, so he deposits it in a bank. Rima runs a business making bamboo products and needs more money than friends and family can lend, so she takes a loan from the bank and will repay it later. The bank uses Navdeep’s spare money to give Rima her loan. A bank is the meeting point of savers and borrowers. To use it, a person or business first opens an account and becomes an account holder.

Kinds of bank accounts

A savings account is for people who save regularly. It earns interest, opens with a small minimum deposit and limits how often money can be taken out each month. A current account is for businesses and traders who pay and receive money often; it earns no interest, but there is usually no limit on transactions. A fixed deposit is a one-time deposit for a set period, such as 3 or 5 years, and usually earns more interest than a savings account.

Interest and compounding

Banks keep deposits safe and also lend them out, so they pay depositors interest, monthly, every quarter or once a year. Suppose you deposit ₹1000 at 6% a year. After a year you have ₹1060. In the second year the interest is 6% of ₹1060, which is ₹63.60, so you have ₹1123.60. Earning interest on interest is called compounding. Left for 12 years, the ₹1000 grows to about ₹2012.20.

The king, the sage and the chessboard

A chess-loving king of Ambalappuzha in Kerala lost a game to a visiting sage, who asked for a modest-looking prize: a single grain on the first square, then twice as many on each square after it: 2, 4, 8 and so on. The top row ended with 128 grains, the 16th square had 32,768, and the 32nd had over 210 crore. Like compounding, doubling makes small amounts huge.

Loans and how banks earn

Banks lend money as loans to buy a house or a vehicle, to study, or to help businesses buy machines and raw materials and launch products. Borrowers repay the loan with interest. Banks pay savers a lower rate than they charge borrowers. If Anand deposits ₹200 at 2%, he gets back ₹204; if the bank lends that ₹200 to Shreya at 5%, she repays ₹210, and the bank earns ₹6. Banks also keep reserves and never lend out every rupee.

Keeping records: the passbook

A passbook is a diary-like record of every deposit and withdrawal, updated at the bank. A debit is money taken out of the account; a credit is money received. Records help you know your balance, spot mistakes or fraud and plan your spending.

Banking for all

According to the book, before 2014 only about 15 crore Indians had bank accounts, and most relied on cash. That year the government began the Pradhan Mantri Jan Dhan Yojana, which offered accounts with no minimum balance and no fees; over 50 crore have been opened, mainly by women. Wages and scholarships now go straight into accounts, which cuts out middlemen.

The RBI and other institutions

The Reserve Bank of India supervises the banking system. Set up in 1935, it has worked as the central bank, the banker to banks, since 1949. It keeps banks’ accounts, lends to banks and the government, prints and issues currency and fixes the benchmark interest rate. Post offices offer savings schemes such as National Savings Certificates, Kisan Vikas Patra and Sukanya Samriddhi; NABARD funds banks that lend for farming and village industries, and IFCI funds industries such as power and textiles. Long ago, temples too lent money, recording the deals on copper plates.

Why it matters

Knowing how banks work helps you save wisely, borrow carefully and read your own passbook. Learn how money moves in digital payments and UPI, and how savings can become part-ownership in shares and the stock market. Answers to the textbook questions are in the NCERT solutions for Part 2 Chapter 8; see all of Part 2 Chapter 8 notes.