What is banking?
- The business of receiving money from depositors (or account holders), safeguarding, and lending money to businesses or individuals is called banking.
- Therefore Banks are institutions that 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 money to people or businesses, banks charge a rate of interest on the amount of money given to us.
The difference between the two is what the bank earns adjusted to their operational costs. In a very simple way we could say:
Banks Earnings = Earning on Money Invested – Interest paid to account holders – Operational cost
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 a change in market conditions.
How do we calculate the interest on the deposit?
Nowadays, because of the powerful computers, 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 deposit, 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:
Maturity Amount = Total Sum Deposited + Interest Earned
If is deposited every month in the bank for
months and
is the rate of interest per year, then
Total Sum Deposited
Proof: If is deposited every month in the bank for
months and
is the rate of interest per year, then
Maturity amount for deposited in the
month after
months
Maturity amount for deposited in the
month after
months
Maturity amount for deposited in the
month after
months
Maturity amount for deposited in the
month after
months
Maturity amount for deposited in the
month after
months
Therefore
how n(n+1)/2*12 comes can you explain.
I have added the proof in the lecture notes. Please refer to it.