With the highest instant access savings accounts offering in excess of 3% interest in your savings it is worth wondering how banks make money on this.
While 3%+ may not sound like an awful lot of interest to you, for the banks they have to play with this money quite a bit to make the sort of money they want to on your savings. In the past banks have taken your savings and either earned a higher interest rate themselves by offering the money back out to borrowers in the form of loans and mortgages, or have gambled it on the markets using what is now referred to as ‘casino banking’.
However with tighter controls on what banks can do with your money to make themselves a bit extra than they are paying you, it is very worthwhile for you to know why banks enter into competitive rates.
The reason is really quite simple. As you should know by now the ‘headline’ rates you see banks offering, i.e. those you will see at the top of the best buy tables, are typically only in place for up to 12 months. After that the amount of interest you earn can drop to as little 0.10%. So having put your savings into an account offering 3%+ you could easily find yourself earning next to nothing in 12 months time.
In fact with the effect of inflation you would effectively be losing money earning an interest rate of 0.10%. Offering a rate this low provides the banks with ample opportunity to earn more than that for themselves. They know that enough savers will stick with them for long enough for them to make some money while paying you a very low rate of interest.
So in really simple terms, the banks rely on you being either lazy to move your savings or unaware of the change in the interest rate paid on your savings, so that they can make money when your rate drops.
Always check the rate you are being paid on your bank and building society accounts to make sure it is what you would want it to be.