It just seems like a semi necessary thing to have to use a bank, why do they pay me a % to keep money there?
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Many people here try to give ELI5 responses using fractional reserve banking, but this must be corrected. The Fed dropped the fractional reserve requirement to zero per cent in 2020. Many countries have no reserve requirement.
When someone deposits to a Bank, this changes the Bank’s balance sheet. A balance sheet is a record of assets the bank has and liabilities. Assets are what the bank owns and liabilities are what it owes.
When a person makes a deposit, there is no net change in the Bank’s balance sheet. The Bank has a new asset, cash reserves, but it also creates an equivalent liability – a deposit – because it owes this money to a depositor.
The bank then exchanges the cash reserves for an asset that earns interest (e.g. a loan to the government, a business or an individual).
Earnings from exchanging the cash reserves for something that earns interest are shared with the depositor as a regular interest payment.
So, why don’t banks make infinite money when the fractional reserve rate is zero?
Risk. Cash reserves have no risk. However, if the bank reinvests the cash reserves in a loan, there is a chance that the loan will not be repaid, so the bank won’t be able to pay the depositor. Riskier investments offer higher payouts but a greater risk of default (non-payment). For example, a loan to a government is much les risky than a loan to a business, so the business must pay more interest.
There are many complex international laws and rules about how banks manage these risks called the Basel regulatory framework. FDIC insurance in the U.S. protects depositors up to a certain amount if the bank cannot repay depositors because too many of its investments have lost value or stopped paying.
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