Expert: Gina Boykin - 8/10/2007

Question
I am referring to savings/checking accounts. In addition to lending out the money on deposit, Do banks use the money in my accounts to invest? If the answer is yes, can they invest in anything they like?  Have I unwittingly given them permission to gamble with my money?

Regards,
Don

Answer
Banks are required to keep a certain percent of the money they have in deposits (checking/savings/money market accounts) in cash.  This is required by the Federal Reserve, and the percent can be changed by the Fed at any time.  This cash may be held in the bank's vaults, or by the local Federal Reserve bank.  These are called "Primary Reserves".

Banks also keep "secondary reserves" which are securities (like government bonds) that banks purchase.  They make money on these securities, and sell them for short-term needs.  Any securities banks purchase will be low-risk and very liquid.

So, for example, if you have $1,000 in the bank, $100 may be in primary reserves and another $100 may be held in securities.

The remaining amount ($800 in this example) can be used to provide loans for consumers and businesses.

From this $800, the bank earns money from these loans - more than it pays to you in interest.  The bank also earns interest on the securities it holds (in its reserves).  Lastly, the bank earns money through fees and sales of other financial products (insurance, financial counseling services, loan servicing).  The money that the bank earns can be invested in mutual funds, stocks, currency, etc.

Because banks are heavily regulated, they are not allowed to invest all of the money you deposit in high-risk investments.  In addition, banks that are member-FDIC are insured.  They pay for this insurance to cover deposits up to $100,000.  If any bank fails, this insurance will make sure that people have access to their deposits.

For more information on banks, you can visit www.howstuffworks.com in their money section.

Best wishes :)

Gina