Have you noticed that banks have been increasing the amount of advertising they run about their high interest rates for checking and savings accounts recently? Why are they doing this, and how are they able to do it? To understand the answer to these questions, you need to understand how fractional reserve banking works.
Banks create money in the economy by making loans. The amount of money that banks can lend is directly affected by the reserve requirement set by the Federal Reserve. The reserve requirement currently ranges from 3% to 10% of a bank’s total deposits, depending on the size of the bank and the amount of risk they take on when making investments. This amount can be held either in cash on hand or in the bank’s reserve account with the Fed.
As an example, if there is a reserve requirement of 10%, when a bank gets a deposit of $100, they can then lend out $90. That $90 goes back into the economy when it is spent on goods or services by the borrower, and eventually ends up deposited in another bank in most cases. That bank can then lend out $81 of that $90 deposit, and that $81 goes into the economy to purchase goods or services and ultimately is deposited into another bank that proceeds to lend out 90% of it, and so on.
When the cost to loan individual money comes down for a bank, the bank can lower your interest on a credit card or financing for a home. The same is true on the banking side, since banks are getting a break lately on the cost to lend, they do not need as much interest from the customer to cover the spread. They could either keep the extra money for themselves or offer an incentive to the customer by providing a higher interest rate on checking and savings accounts. The result of this is high yield checking, which benefits current customers and entices new customers to open an account. Since banking has become so competitive, most banks follow suit so they can continue to compete.
The banks do put stipulations on some of these accounts that you need to be aware of. There may be limits on withdrawals or the number of checks you write, and you may have to have to complete a minimum number of transactions each month. The banks put these stipulations in place to tilt the balance of your relationship with them in their favor. Limiting withdrawals keeps more of your money in the bank so it is available for them to invest and profit from. Limiting the number of checks you write saves the bank money by cutting down on their processing costs and it also forces you to use your debit card more, generating fees for the bank. They have a minimum number of transactions per month for the same reason. Since the bank is making money from you, it makes sense for you to try to get some of that money back in an interest bearing checking or savings account. One example is interest checking Ohio, which is offering a great interest rate and a refund on ATM fees up to $12 per month.
There may be penalties for not abiding by these stipulations, like increased monthly fees, but most of the requirements put in place by the banks are not overly restrictive. Overall, these higher interest rates for checking and savings accounts are a great opportunity to a little help with finances, which everyone could use these days.