In simplistic terms a deposit taking and lending body such as a bank, building society or savings and loan company takes in money from savers and pays them interest for the use of that money. The bank then lends that money to a borrower and charges them interest on the loan. The lending company also needs money to administer the deposits and the loan. They also need to make a profit.
So the profit and administration costs come out of the gap between the interest charged to borrowers and that paid out to savers.
Need to Set Aside Funds to Cover Default on Loans
In the real world some borrowers will not meet their commitments and repay the loan and interest. The lending bank needs to build that into their administrative costs so that they can meet their commitment to their depositors, the savers. That means that in difficult times, such as recessions, when there tend to be more defaults on loans those administrative costs will increase.
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