Banking sector Banks perform two crucial functions. First, they receive
funds from depositors and, in return, provide these depositors
with a checkable source of funds or with interest payments.
Second, they use the funds that they receive from depositors to
make loans to borrowers; that is they serve as intermediaries in
the borrowing and lending process.
When banks receive deposits, they do not keep all of
these deposits on hand because they know that depositors will
not demand all of these deposits at once. Instead, banks keep
only a fraction of the deposits that they receive. The deposits
that banks keep on hand are known as the banks”reserves.
When depositors withdraw deposits, they are paid out of the
banks” reserves. The reserve requirement is the fraction of
deposits set aside for withdrawal purposes. The reserve
requirements is determined by the nation”s bank authority, a
government agency known as the central bank. The central
bank is unique in that it is the only bank that can issue
currency. Deposits that banks are not required to set aside as
reserves can be lent to borrowers, in the form of loans. Banks
earn profits by borrowing funds from depositors at zero or low
rates of interest and using these funds to make loans at higher
rates of interest.
