What is banking?
- Business of receiving money from depositors (or account holders), safe guarding and lending money to business or individuals is called banking.
- Therefore Banks are institutions which carry out the business of taking deposits and lending money.
- When people deposit money, based on the scheme under which they deposit money, they get a return on their money.
- Similarly, when the bank lends the money to people or business, banks charge a rate of interest on the amount of money given our.
The difference in the two is what the bank earns adjusted to their operational costs. In a very simple way we could say:
Off-course, banks have to take a banking license to start bank operations.
Types of Accounts: There are many types of accounts but from a course perspective, we will look at the following accounts:
- Savings Bank Account
- Recurring Deposit Accounts
Saving Bank Account
A person can deposit and withdraw money at will. The person gets a certain interest on the deposits, which could change with change in market conditions.
How do we calculate the interest on the deposit?
Now a days, because of the powerful computers, the banks are able to calculate interest on a day to day basis. However, for our syllabus, we would calculate interest on a monthly basis. The concept is the same though. Here is how we will do it.
- Find the minimum balance on the day and up to the last day of each month. This minimum balance becomes the principal of the month.
- Add all such Principal amounts obtained for different months of a particular period in consideration.
- Now calculate the simple interest on the Principal obtained in Step 2 for one month at the prevailing rate of interest at that time.
Recurring Deposit Account
In this type of deposits, the account holder deposits a specified amount in the account every month for a fixed period of time. It could be three months to say 10 years. The time period is decided by the bank.
At the expiry of the period, the person gets a lump sum of money which includes the money that was deposited and the interest (compounded quarterly) that the money has earned over a period of time.
The formula that we use for calculating the maturity value of the recurring deposit is:
If is deposited every month in the bank for months and is the rate of interest per year, then