Banking

What is Compound Interest (Banking)?

Compound interest means you earn interest on your original deposit plus interest on the interest you’ve already earned. It’s how savings can grow faster over time. Unlike simple interest, which is calculated only on the principal, compound interest allows savings to grow exponentially over time. Banks compound interest at various frequencies—daily, monthly, or quarterly—and this compounding frequency directly increases the Annual Percentage Yield (APY) disclosed under Regulation DD.

The mathematical formula for compound interest is A = P(1 + r/n)^(nt), where A is the final amount, P is the principal, r is the annual interest rate, n is the compounding frequency, and t is the time in years. Over long periods, compounding frequency significantly impacts total yield.

Quick Facts

Interest BasisCalculates interest on principal plus accumulated interest

Compounding FrequenciesDaily, monthly, quarterly, or annually

Regulatory DisclosuresDetermines the APY under Regulation DD

Mathematical EffectAccelerates savings growth over time

PRACTICAL EXAMPLE

A customer deposits $10,000 into a 5-year savings account offering a 5.0% interest rate. With simple interest, they would earn $2,500 total ($500 per year). With daily compounding, they earn $2,840.03 total, gaining an extra $340.03 due to interest earning interest.

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Learn More Key Concepts

Simple InterestInterest calculated solely on the original principal amount, without compounding on accumulated interest.

APY (Annual Percentage Yield)The real annual rate of return earned on a deposit account, accounting for the compounding of interest over one year.

Savings AccountAn interest-bearing deposit account held at a financial institution, designed for accumulating funds with high liquidity.

Time Value of MoneyThe financial principle that money available now is worth more than the same amount in the future due to its earning potential.

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