Final answer:
A lender collects and holds taxes in an escrow account used to manage funds for specific expenses such as property taxes and insurance. Banks, using these accounts, ensure timely payments for expenses associated with loans they provide to protect both the borrower and their own interest.
Step-by-step explanation:
The lender collects and holds taxes in an escrow account, which is used to fund specific expenditures such as insurance and property taxes associated with a loan. For instance, when purchasing a home, lenders often require borrowers to pay a portion of their estimated annual property taxes and homeowners insurance into an escrow account, from which the lender will make payments when they are due. This ensures that these crucial payments are made on time, protecting both the borrower's investment and the lender's collateral on the loan.
Using Singleton Bank as an example, it may hold $10 million in deposits, and as part of its operations, it may use escrow accounts to manage property taxes and insurance on the loans it underwrites. Similarly to how government trust funds, like those for Medicare or Social Security, work by collecting taxes and investing that money until they pay it out, banks use escrow accounts to hold and manage funds for specific purposes.
Basic banking principles indicate that while banks like Singleton Bank may not earn interest from holding deposits in vaults as detailed in the hypothetical T-account balance sheets (like Figure 27.6 or Figure 14.5), the management of escrow accounts can be an integral aspect of lending money at interest and maintaining financial order for the bank's customers.