Question

How is it possible for investment to be bigger than savings just because we have banks in the system? Why is it a good thing that banks can lend out more money than was deposited?

Answer 1

1.The relationship is all about the compounded rate of return. Saving, by itself, has a compounded rate of return of zero (ignoring inflation, which is another story). If you combine savings with investing, your money will grow faster than if you just put it in a box.
If you managed to save a thousand dollars and invested that for a steady, secure return of 7%, it would double to $2,000 in ten years.
Now imagine doing that every year for forty years. By investing your $1,000 annual savings at a (idealized) 7% return, you will have over $200,000 after 40 years. Compare that with the $40,000 you would have if you just saved without investing and you will begin to have an appreciation for the relationship between saving and investing.

Investments are possible since we have banks and other financial institutions in the country.

2. Traditional introductory economic textbooks generally treat banks as financial intermediaries, the role of which is to connect borrowers with savers, facilitating their interactions by acting as credible middlemen. Individuals who earn an income above their immediate consumption needs can deposit their unused income in a reputable bank, thus creating a reservoir of funds from which the bank can draw from in order to loan out to those whose incomes fall below their immediate consumption needs.

Expectations of profitability then, remain one of the leading constraints on banks’ ability, or better, willingness, to lend. And it is for this reason that although banks don’t need your money, they do want your money. As noted above, banks lend first and look for reserves later, but they do look for the reserves.

Attracting new customers is one way, if not the cheapest way, to secure those reserves. Indeed, the current targeted fed funds rate – the rate at which banks borrow from each other – is between 0.25% and 0.50%, well above the 0.01% to 0.02% interest rate the Bank of America pays on a standard checking deposit. The banks don’t need your money; it’s just cheaper for them to borrow from you than it is to borrow from other banks.