how a bank uses a term deposit
if a customer places money in a term deposit the bank can invest the money in other financial products that pay a higher rate of return ror than what the bank is paying the customer for the use of their funds the bank can also lend the money out to its other clients thereby receiving a higher interest rate from the borrowers as compared to what the bank is paying in interest for the term deposit for example a lender may offer a 2 rate for term deposits with a two year maturity the funds deposited are then structured as loans to borrowers who are charged 7 in interest on those notes this difference in rates means that the bank makes a net 5 return the spread between the rate the bank pays its customers for deposits and the rate it charges its borrowers is called net interest margin net interest margin is a profitability metric for banks banks are businesses as such they want to pay the lowest rate possible for term deposits and charge a much higher rate to borrowers for loans this practice increases their margins or profitability however there is a balance the bank needs to maintain if it pays too little interest it won t attract new investors into the term deposit accounts also if they charge too high of a rate on loans it won t attract new borrowers term deposits and interest ratesin periods of rising interest rates consumers are more likely to purchase term deposits since the increased cost of borrowing makes savings more attractive also with higher market interest rates the financial institution will need to offer the investor a higher rate of interest so the investor also earns more 