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Flick

Fractional Reserve Banking & Interest Rates

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Heres something thats been bugging me for a little, ever since I got my head round fractional reserve banking. Or at least since I thought I got my head round it.

In the following example, I've left tax, bad debt etc out for simplicities sake.

I deposit £100 in a bank at say 5% interest, and they can lend out 7* that amount at say 7%

Then after a year, I have £105.

After a year, they get their £749 quid back &(700@ 7)%, £600 disappears, as it never really existed. Meaning they make 49% on my £100 minus my 5%, giving them a profit of 44%

So why are these crappy 8-10% regular savings accounts touted as 'loss leaders' ?

Surely a low overhead internet bank could afford to pay in excess of 20% ?

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They make money buy charging more interest than they give ..... they give 5% .... but charge 7%

So if they were gonna give 20% to savers ..... they would have to charge 22% to spenders .....

Cos otherwise the cost of borrowing would only be 7% .... but saving would receive 20% ..... therefore everybody and his uncle would be out borrowing the banks money and then giving it back into a savings account to make a tidy profit !!!

Borrow £100,000 at 7% p.a. = £107,000 to pay back after a year

Put that borrowed 100K in a Savings account giving 20% p.a. = £120,000 with interest after a year

= 13 Grand profit for doing sod all :D If only !!! :)

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After a year, they get their £749 quid back &(700@ 7)%, £600 disappears, as it never really existed. Meaning they make 49% on my £100 minus my 5%, giving them a profit of 44%

Hi Flick

I don't think it's quite like that. Remember that each one of those subsequent loans is in turn banked by someone, and they'll earn your 5% interest before being loaned out again at 7%.

For example:

  1. Person A deposits £100 - they earn £5 interest (5%)

  2. Person B takes out a £90 loan - they pay £6.30 interest (7%) - the bank can only lend out 90% as 10% needs to be kept on reserve. Person B pays Person C (builder for example) £90 for a job

  3. Person C deposits £90 - they earn £4.50 interest

  4. Person D takes out a £81 loan - they pay £5.67 interest

  5. etc - I think they can end up creating 10 times the amount of money (out of thin air!) that was initially deposited.

So, taking all that into account, the bank end up taking £1000 in deposits and lending out £900. They pay 5% on the £1000 which give £50 and making 7% on the £900 in loans giving £63. This gives them a £13 profit on your initial deposit of £100 - a profit of 13%. Still, not bad for doing feck all!

Of course, if you take credit cards into account with interest rates at 15%, you can see the profit margins being massive - no wonder they're so keen for you to have one!

(PS - please correct me if I'm wrong, as the above is my understanding of fractional reserve banking)

Regards,

crude

Edited by crudeFool

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It works in BOTH ways !!

As you say above they turn £1 into £10 by effectively depositing and re-loaning the SAME money !!

But the fractional reserve is a seperate issue which gives the bank 10 times the lending power of its initial deposits i.e :

- a bank has one million in deposits

- it "calculates" that at any one time only 10% of that money will be called for withdrawal

- it lends out ten million from the backing of the one million held

Basically they lend out money which doesn't really exist ..... which is then filtered through debt throughout the economy making it seem real ..... however when the debt is paid, the "money" once again vanishes ......

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It works in BOTH ways !!

<snip>

Yep - agreed.

I saw another thread a while back saying that a bad debt in amongst that can really screw the bank. If they have to write off £100K, that £1M worth of loans they can't make as it comes straight out of the 10% reserve they hold.

As you say, being highly leveraged works both ways - big profits when things are rosey, bankruptcy if things go t*ts up!

Regards,

crude

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Yep - agreed.

I saw another thread a while back saying that a bad debt in amongst that can really screw the bank. If they have to write off £100K, that £1M worth of loans they can't make as it comes straight out of the 10% reserve they hold.

As you say, being highly leveraged works both ways - big profits when things are rosey, bankruptcy if things go t*ts up!

Regards,

crude

Are you sure?

I thought the main reason that fractional reserve banking was such a monstrous thing is that banks are essentially creating money out of nothing as a debt, and then charging interest on it.

A practice that began with the Goldsmiths hundreds of years ago where they realised it was highly unlikely that all the customers would come and claim their gold at any one time; so they could create more gold receipts than they actually had, with nobody knowing otherwise, lend them out and make *even more* profit.

It started out as a scam and still is one AFAIU.

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It works in BOTH ways !!

As you say above they turn £1 into £10 by effectively depositing and re-loaning the SAME money !!

But the fractional reserve is a seperate issue which gives the bank 10 times the lending power of its initial deposits i.e :

- a bank has one million in deposits

- it "calculates" that at any one time only 10% of that money will be called for withdrawal

- it lends out ten million from the backing of the one million held

Basically they lend out money which doesn't really exist ..... which is then filtered through debt throughout the economy making it seem real ..... however when the debt is paid, the "money" once again vanishes ......

Thanks all for the input.

So surely they are charging interest on 10x the money, and only paying interest on 1x ?

My question still stands - why cant they pay me more interest !!!! - other than the perpetual money creation thing you mentioned :)

Edited by Flick

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Guest Charlie The Tramp

Yep - agreed.

I saw another thread a while back saying that a bad debt in amongst that can really screw the bank. If they have to write off £100K, that £1M worth of loans they can't make as it comes straight out of the 10% reserve they hold.

As you say, being highly leveraged works both ways - big profits when things are rosey, bankruptcy if things go t*ts up!

Regards,

crude

See Here

FRB Explained In Simple Terms

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Thanks for the link, I've read it and it still doesnt really make a lot of sense.

now it looks like they could be lending out 30x my deposit. And making interest 30X on it!!!!

Surely my plea for 20% interest is a pittance to them!

How can I open my own bank? :)

Edited by Flick

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  • 301 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



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