How Do Banks Make Money - Seriously!

[laura122]

I have savings that I put in Santander and earn 3% interest on

I can obtain a mortgage at 2.5% - They will also pay for my valuation and legal fees

Seriously - How do banks make money like this - All i can think of is that they are able to lend 10*deposits

If that is the case do they not pay interest on any leverage they have created

[interestrateripoff]

They borrow the money from the Fed at near 0% and then ramp up food/oil price.

You think your getting a good deal, whereas the banker still has you bent over giving you a good shafting.

Although the UK base rate is 0.5%, so they can borrow that and give you a mortgage at 2.5%, I'm guessing what they make on that will more than cover the 3% they give you.

[bmf]

They borrow the money from the Fed at near 0% and then ramp up food/oil price.

You think your getting a good deal, whereas the banker still has you bent over giving you a good shafting.

Although the UK base rate is 0.5%, so they can borrow that and give you a mortgage at 2.5%, I'm guessing what they make on that will more than cover the 3% they give you.

Disagree. Recent problems are due to assuming lending has too little risk. Banks should have charged higher rates to sub-prime borrowers as they were at high risk of default, as we now know. The government guarantees via Mac + Mae didn't help but my point stands.

[mfp123]

mortgages are funded by the money markets where interest rates are much lower, currently about 0.75%.

dont forget normal bank loans maybe be 7-8%, credit card and overdrafts are 15%, so they still make money from paying you 3% on your deposits.

[gf3]

2.5% for how long? If it is the full 25 years then great but somewhere along the line you will move to SVR.

Investment banks make money by gambling and retail banks make money by paying depositors x % and charging borrowers x + 2%.

Yer but I'm borrowing at 0.67% and they pay me 5.15%. Wasn't there a thread that said one bank was borrowing from the bank of England at 0.75%. So why do they borrow off me at 5.15%

[interestrateripoff]

Yer but I'm borrowing at 0.67% and they pay me 5.15%. Wasn't there a thread that said one bank was borrowing from the bank of England at 0.75%. So why do they borrow off me at 5.15%

Capital.

[interestrateripoff]

Disagree. Recent problems are due to assuming lending has too little risk. Banks should have charged higher rates to sub-prime borrowers as they were at high risk of default, as we now know. The government guarantees via Mac + Mae didn't help but my point stands.

Lending has no risk. How many deposit banks have gone bust?

None. All got rescued.

B&B, Northern Rock, RBS, HBoS did the bond holders take a hair cut?

When the Banks lent the Asians billions which went tits up in 97/98 all the western banks got bailout via the IMF, again no losses.

Banking is a risk free business, which is why lending money to people on welfare checks made sense to get the bonus, when it went wrong the bankers knew they'd get bailed out and get another bonus.

You have to think like a banker how can I get a bonus.

[gf3]

Capital.

OK I will have to admit I don't fully understand all this. Is there an idiots guide any where

[Maynardgravy]

They don't.

They shove it in a can and kick it as hard as they can down the road.

[interestrateripoff]

OK I will have to admit I don't fully understand all this. Is there an idiots guide any where

Banks stay in business having capital, ie deposits which is why a bank run is so lethal. They have to maintain a certain capital ratios to stay in business and get to borrow cheap money which they can leverage up.

So they lure you in with what you think is a great rate and then they can leverage that up at the local central bank. Banks are highly leveraged, ie your deposit allows them to borrow for example 16x more.

Now I'd be quite prepared to give you 3% on your £10,000 (ie £300 a year interest) savings if that allows me to borrow £160,000 at say 0.5% and lend it out at 2.5% (ie netting the bank £4000 in interest although you need to minus the central bank take £800) so that's profit of £2900. I'm sure what I'm doing is a huge over simplification but I'm hope you can start to think like a banker chasing a bonus.

Now start factoring in betting the price of oil/food etc... and just drool over the bonus pool.

[Compounded]

OK I will have to admit I don't fully understand all this. Is there an idiots guide any where

How today’s fiat currency systems work

In all the world’s fiat currency systems, all currency is created by the act of borrowing. Currency is initially created by the government borrowing currency from its central bank (or ‘reserve’ bank), which the central bank creates out of thin air (the act of borrowing is inseparable from the act of creating the currency out of thin air, so we say the currency is ‘created by borrowing’) Also the use of the word “borrowing” conveniently hides from the population that money is simply being created from nothing.

However bank lending creates most currency:

• The bank can lend about 90% of deposits made to it out. This system is called ‘fractional reserve banking’, because the bank retains a fraction of deposits as a reserve then lends out the rest.

• The depositors still have their currency in the bank, while borrowers also have currency to spend. Hence, borrowing creates new currency.

• The borrowed currency nearly always ends up as a deposit in a bank, where 90% of it can be lent out again. And so on. In this manner, for each dollar that is deposited, up to $10 of loans i.e. new money can eventually be created by the banking system.

• As a loan is paid off the principal part of the loan is destroyed, that money ceases to exist. The bank however keeps the interest.

• The system is safe enough as long as not too many bank depositors withdraw their currency at once and defaults are few.

• Money in bank accounts securing loans remains available to be spent because, most spending is by card, cheque and electronic transfer; this money does not leave the banking system but is still available to be spent over and over.

By the way, ‘printing’ only creates physical notes or coins to be substituted as required for the currency created by borrowing—printing does not actually create the currency. At least 97% of currency exists as numbers in bank accounts.

Thus:

• All fiat currency is someone’s debt. Someone out there is paying interest on every unit of fiat currency. Most people are surprised to learn that in today’s system if every debt were repaid there would be no money.

• A fiat currency is essentially a system of IOU’s, a system of credit.

• Lower interest rates encourage borrowing and thus increase the rate of growth in the amount of currency.

• Higher interest rates discourage borrowing and thus decrease the rate of growth in the amount of currency and after a delay price inflation rate slows in response.

• The amount of currency owing on loans (the amounts borrowed plus interest) is more than the total amount of the fiat currency in existence (the amounts borrowed). So either the amount of fiat currency must continually increase, or there will be many failures to repay loans. A fiat currency system must expand to survive.

Some quotes on this system.

"The bank hath benefit of interest on all moneys which it creates out of nothing."

William Paterson, founder of the Bank of England in 1694, then a privately owned bank.

"Let me issue and control a nation's money and I care not who writes the laws." Mayer Amschel Rothschild (1744-1812), founder of the banking House of Rothschild.

"The few who understand the system will either be so interested in its profits or be so dependent upon its favours that there will be no opposition from that class, while on the other hand, the great body of people, mentally incapable of comprehending the tremendous advantage that capital derives from the system, will bear its burdens without complaint, and perhaps without even suspecting that the system is inimical to their interests." The Rothschild brothers of London writing to associates in New York, 1863.

"Banking was conceived in iniquity and was born in sin. The Bankers own the Earth. Take it away from them, but leave them the power to create deposits, and with the flick of a pen they will create enough deposits to buy it back again. However, take it away from them, and all the fortunes like mine will disappear, and they ought to disappear, for this world would be a happier and better world to live in. But if you wish to remain slaves of the Bankers and pay for the cost of your own slavery, let them continue to create deposits." Sir Josiah Stamp, President of the Bank of England in the 1920s, then the second richest man in Britain.

"I am afraid the ordinary citizen will not like to be told that the banks can and do create money. And they who control the credit of the nation direct the policy of Governments and hold in the hollow of their hand the destiny of the people." Reginald McKenna, as Chairman of the Midland Bank, addressing stockholders in 1924.

"The banks do create money. They have been doing it for a long time - I doubt very much whether you would get many prominent bankers to attempt to deny that banks create it." H W White, Chairman of the Associated Banks of New Zealand, to the New Zealand Monetary Commission, 1955.

Politicians

"I believe that banking institutions are more dangerous to our liberties than standing armies." Thomas Jefferson, US President 1801-9.

"When a government is dependent upon bankers for money, they and not the leaders of the government control the situation, since the hand that gives is above the hand that takes. Money has no motherland; financiers are without patriotism and without decency; their sole object is gain." Napoleon Bonaparte, Emperor of France.

"If the American people ever allow private banks to control issue of their currency, first by inflation, then by deflation, the banks and the corporations will grow up around them, will deprive the people of all property until their children wake up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs." Thomas Jefferson in the debate over The Re-charter of the Bank Bill (1809).

"Money plays the largest part in determining the course of history." Karl Marx writing in the Communist Manifesto (1848).

“The surest way to overturn the existing order of society is to debauch the currency, all the hidden forces of economics are unleashed on the side of destruction in a way that not one man in a million can diagnose”. Karl Marx.

"The government should create, issue and circulate all the currency and credits needed to satisfy the spending power of the government and the buying power of consumers. By adoption of these principles, the taxpayers will be saved immense sums of interest. Money will cease to be master and become the servant of humanity." Abraham Lincoln, US President 1861-5. He created government issued money during the American Civil War and was assassinated.

"The death of Lincoln was a disaster for Christendom. There was no man in the United States great enough to wear his boots and the bankers went anew to grab the riches. I fear that foreign bankers with their craftiness and tortuous tricks will entirely control the exuberant riches of America and use it to systematically corrupt civilisation." Otto von Bismark (1815-1898), German Chancellor, after the Lincoln assassination.

“It is well enough that the people of the nation do not understand our banking system, for if they did, I believe there would be revolution before tomorrow morning” Henry Ford

"Of all contrivances for cheating the laboring classes of mankind, none has been more effective than that which deludes them with paper money." -- Daniel Webster"

[shermanator]

Lending has no risk. How many deposit banks have gone bust?

None. All got rescued.

B&B, Northern Rock, RBS, HBoS did the bond holders take a hair cut?

When the Banks lent the Asians billions which went tits up in 97/98 all the western banks got bailout via the IMF, again no losses.

Banking is a risk free business, which is why lending money to people on welfare checks made sense to get the bonus, when it went wrong the bankers knew they'd get bailed out and get another bonus.

You have to think like a banker how can I get a bonus.

Yes but I think now we're seeing the endgame for Lloyd's and HBOS as quoted entities - they're bust and either this year or next they'll be fully nationalised after a bank run or the shares drop even further. Same fate could befall Barclays too.

Nationalised banks is the endgame as the debts are just too large to sustain.

[winkie]

They don't.

They shove it in a can and kick it as hard as they can down the road.

...then keep rolling it over.

[Guest tbatst2000]

I have savings that I put in Santander and earn 3% interest on

I can obtain a mortgage at 2.5% - They will also pay for my valuation and legal fees

Seriously - How do banks make money like this - All i can think of is that they are able to lend 10*deposits

If that is the case do they not pay interest on any leverage they have created

They pay interest, but mostly not very much (although they do provide banking services such as cash points and the like as well). Also, most people are paying more than 2.5% for their mortgage.

edit: take a look here to see what their funding costs are:

http://www.bankregdata.com/bkIEmet.asp?met=FND&inst=HC1239254

As of Q1 2011, they were funding at 1.25%, so charging you twice that for your mortgage doesn't seem overly generous.

Edited August 13, 2011 by tbatst2000

[getknk]

I feel they will put in banks in India /China !!

the banks over there should provide 10% rates !!

[Bloo Loo]

I have savings that I put in Santander and earn 3% interest on

I can obtain a mortgage at 2.5% - They will also pay for my valuation and legal fees

Seriously - How do banks make money like this - All i can think of is that they are able to lend 10*deposits

If that is the case do they not pay interest on any leverage they have created

which bank is giving mortgages at 2.5%?

[gf3]

which bank is giving mortgages at 2.5%?

First direct do a life time tracker at 2.59% or a 2 year tracker at 2.39%

[Bloo Loo]

First direct do a life time tracker at 2.59% or a 2 year tracker at 2.39%

sorry, the 2.59% is with 35% of your money in the house itself, earning 0 interest, and £1599 fee, and even thay say the APR is 3.7%,

Probably similar caviats on the other one too.

now, where is the "Ive put my money in a house or I could have a mortgage that was cheaper"...deal?

Teaser rates are what killed people in 2007 and meant they cant repay now.

Edited August 14, 2011 by Bloo Loo

[ChumpusRex]

So they lure you in with what you think is a great rate and then they can leverage that up at the local central bank. Banks are highly leveraged, ie your deposit allows them to borrow for example 16x more.

Now I'd be quite prepared to give you 3% on your £10,000 (ie £300 a year interest) savings if that allows me to borrow £160,000 at say 0.5% and lend it out at 2.5% (ie netting the bank £4000 in interest although you need to minus the central bank take £800) so that's profit of £2900. I'm sure what I'm doing is a huge over simplification but I'm hope you can start to think like a banker chasing a bonus.

Total drivel. Customer accounts are not capital and banks cannot leverage against them.

Capital is the "company's own money" that is owed to no one. It is:

1. equity that shareholders have injected into the business through an initial sale of shares, or a rights issue (which they have no way of recovering, except by sale of stake), or

2. genuine profits made from business activity which have been retained in the business which have neither been paid to shareholders, nor lost in failed investments/business expenses.

For banks, there are more requirements. Banks must maintain a minimum level of capital, but that minimum level does not count capital which has been invested, except in ultra-low risk investments (e.g. government gilts).

It is the capital, injected by the shareholders, that permits the bank to take a deposit from a customer, and then loan those savings out as a mortgage. Without that shareholder's capital, the bank would not be able to lend that mortgage, and would have to hold the saver's cash as cash, where it could not earn a return.

Edited August 14, 2011 by ChumpusRex

[easy2012]

Whilst a true distinction, it is not true that deposits cannot be leveraged by the simple working of the (quasi) FRB system that is operated within the entire banking system. Hence why money is about 3% and credit is about 97% of our money supply. The fact that 'money' and 'credit money' is fungible just makes it hard for people to draw the distinction between the two.

I am afraid you have confused the traditional FRB that are posted on the internet with the Risk Weighted Asset (RWA) regime practised in the UK.

Those countries that uses FRB as you described never allow their banks to go to 33x leverage. In China, where reserve to lending ratio is used, the leverage is <10x.

In UK, deposit does not have a direct impact on how much the bank can lend. It affects how banks are funded - if the banks uses lots of wholesale funding, then it is likely to be exposing itself to this unstable source of fund. If it borrows from BoE at discount window - it is a bit more expensive and carries a stigma.

Retail deposit remains the most stable and best quality source of funding.

Edited August 14, 2011 by easybetman

[easy2012]

Yer but I'm borrowing at 0.67% and they pay me 5.15%. Wasn't there a thread that said one bank was borrowing from the bank of England at 0.75%. So why do they borrow off me at 5.15%

5.15%? Is that a 5 years fixed rate deposit compared against a pre 2007 base rate tracker lending (0.67%)?

Before you are too pleased with yourself, I would expect that a shareholder friendly bank would review your mortgage from time to time to see if the LTV stills holds and demand that either you put up more equity or move you to a 'better' product shall the LTV falls short.

[Injin]

Baks don't exist to make money, they exist to transfer resources.

[ChumpusRex]

Before you are too pleased with yourself, I would expect that a shareholder friendly bank would review your mortgage from time to time to see if the LTV stills holds and demand that either you put up more equity or move you to a 'better' product shall the LTV falls short.

That would be the ideal. However, there is not a single owner-occupier mortgage that permits the lender to alter the terms of the mortgage, purely due to a change in the value of the property.

This might be the case for BTL mortgages, but it isn't for the overwhelming majority.

[easy2012]

That would be the ideal. However, there is not a single owner-occupier mortgage that permits the lender to alter the terms of the mortgage, purely due to a change in the value of the property.

This might be the case for BTL mortgages, but it isn't for the overwhelming majority.

Thanks for the correction. I think you are correct.

[laura122]

Total drivel. Customer accounts are not capital and banks cannot leverage against them.

Capital is the "company's own money" that is owed to no one. It is:

1. equity that shareholders have injected into the business through an initial sale of shares, or a rights issue (which they have no way of recovering, except by sale of stake), or

2. genuine profits made from business activity which have been retained in the business which have neither been paid to shareholders, nor lost in failed investments/business expenses.

For banks, there are more requirements. Banks must maintain a minimum level of capital, but that minimum level does not count capital which has been invested, except in ultra-low risk investments (e.g. government gilts).

It is the capital, injected by the shareholders, that permits the bank to take a deposit from a customer, and then loan those savings out as a mortgage. Without that shareholder's capital, the bank would not be able to lend that mortgage, and would have to hold the saver's cash as cash, where it could not earn a return.

Probablly the most sensible answer in the thread - If this was the case then surely as bank equity prices tumble the bank has to actually stop lending as it no longer has capital?

And just look at FirstDirect / Accord mortgages for examples of ~2%APR mortgages for 2 years