Why banks love to lend

Hopefully by now it is a bit clearer how the banks work – that is if you were not already enlightened!  But let’s reduce it to some simple numbers and you will see just how profitable it is for banks to lend money.  Before that, sit down, pour a stiff drink and don’t get too upset.  This has been going on for years!

Suppose you borrow £10,000 over 4 years – to buy a car for example. Assume that the bank will charge you 8% per annum interest – probably as good as you can get in the UK at the moment for an unsecured loan. A repayment calculator will show you that the monthly payment for this is about £244.13 and that you will pay in total £11,718.24 with £1,718.24 of this being interest.

Of course as far as the customer is concerned, they just see the 8% or so and this seems reasonable.  If you borrowed the money from under Uncle George’s mattress, you would of course want to pay him some interest because he couldn’t use the money – he would be ‘out of the money’ as they say.

But the profitability for the banks is a completely different kettle of fish.

Under fractional reserve banking, all the bank actually has to have to lend this money is 10% of the sum. So in order for the bank to write this loan, they have to have only £1,000 – the rest is created in the belief that you will pay it back, which you do because otherwise you will get a bad credit score and end up like Greece.

What is the real interest charged – the rate that the bank sees on the actual money that they have to commit to your loan? Again back to the rate calculator and you will see that the interest charged by the bank based on the actual money lent, or £1000, is an eye-watering 292.95%! And of the total repayment of £11,718.24, all but £1,000 is interest.  You don’t believe me?   Do the sum yourself – there are enough online interest calculators available.  First calculate the monthly payments for the loan then copy that number back into the calculator altering the amount lent from £10,000 to £1,000.

What would the interest rate have been before the big crash of 2008 – when the banks only had to have 3% at call? Again a little sum shows you that it is 976.52%. Do you see why the banks just ‘lurve’ fractional reserve banking?

Do the same with mortgages. Suppose you have a £100,000 repayment mortgage at 4% over 20 years – quite a modest one for the UK. This works out at £605.98 a month. Now realise that because the actual money that the banks had to have was just £10,000, the real interest rate is revealed as 72.72%. Nice, hey? Before the crunch it was 242.39%.

Now to credit cards – but first freshen that drink or make it a double.

Consider a card balance of £10,000 with a monthly rate of 2% as quoted. Suppose only the minimum payment is made and this barely covers the interest so the balance hardly changes – it happens! The apparent interest rate is just 26.8% – steep but that is the rate charged by many cards.  Let’s forget the trivial amount they charge the shopkeeper as well – although at up to 5% that is not chicken feed to hard-pressed traders.

What is the real interest rate? A simple calculation shows that the real interest rate is 791.6%! And before the crunch – are you still sitting down – it was 45,839%.  Yes, over 45 thousand percent!  Phew!

Put this another way.  In ONE YEAR they multiplied their money 460 times.  And in this very simple scenario, you still haven’t paid a penny of the debt.  Nice one.

Imagine you are a bank.  You spot a credit card – not a person’s but a system that has a lot of card holders.  Now generally about half of accounts are cleared every month – boo hoo (well the banks still make from the traders so no tears please!).  But assume that all these customers are rolling their balances over.  What is that book worth?  Even if they pay the full amount, suppose £1billion, they can then do what they like because credit cards are essentially unregulated.  Maybe the card is charging 1.2% a month which amounts to 15.4% a year, a ‘reasonable’ credit card interest rate.  That will amount to 289.6% a year or 2.9 times the money.  Now suppose the bank is a little hard pressed and wants to make some money to repay Uncle Sam or whoever has bailed it out with the taxpayers’ hard earned cash.  So over 12 months it doubles the interest rate for no real reason.  The return jumps to 1221% or 12 times so hello £12 billion.  Bye bye Uncle Sam – keep the government out of our books please!  Can you think of such examples?  Because I can!

Which of these types of lending do you think that banks prefer? Well credit cards, particularly judging by my junk mail.  But the truth is – with fractional reserve banking they love all lending. It’s what feeds their massive profits.

At the moment they are not lending so much, partly to shore up their walls in case the worst happens – after all they don’t want to be caught with their trousers down again – but I suspect more because they are playing with us. They have the only game in town so they are threatening to take their ball away. Of course if they don’t lend, they will take a hit on all their investments but there is enough fat for them to take a lending holiday, reduce their tax bill and, best of all, it gets the politicians down on their knees begging them to lend. What a nice position to be in!

Yet of course banks don’t actually  make anything, they don’t dig any oil out of the ground, carry out life-saving operations, invent new gadgets, grow the food, care for old people, sweep the streets or have anything to do with the goods and services that are – or have become – essential to life.  No, they just handle the money that enables these things to be done.  So they are essential as I showed last week but we have got it all out of balance – it’s not so much money that makes the world go round but money that puts the banks completely in charge. And do you wonder that financial institutions have ended up owning everything, including us?  This is why the banks must be brought in from the heat, why some sort of control must be exerted upon them and why I have made the suggestions in my earlier posts.

Is it any wonder that people are fed up with the banks and have taken to the streets, even in Britain where a complicit government has not exactly helped?  Do you expect your government to do anything about it?

14 thoughts on “Why banks love to lend”

    1. Thanks @NWB – it was a shock when I realised just how profitable the whole lending game is but I have never seen it written down! Before I thought about it I was under the misapprehension that they made their profit on the difference between lending and borrowing rates but it always puzzled me how they made such massive profits on that basis alone.

      I don’t expect government to do much but I can always hope!

  1. Banking and credit cards are very profitable, but it takes a lot to get into that business. Most of us do not want to get into it because it is so regulated.

    1. Well @KC the regulation hasn’t worked too well in recent years. And look at the profitability not to mention some of the bonuses paid when the taxpayer has ended up carrying the can! I think it takes a lot to get in not so much because of the regulation but it is essentially a cartel of financial institutions who all own each other and can freeze out newcomers if they want.

  2. That is exactly why the EU and the US banking systems are in trouble. The capital reserves banks are required to have on hand has been adjusted upwards and the banks are trying to delay having to comply. I also heard on the news today that the US Federal Reserve was forced to disclose under the freedom of information act the total cost of the financial crisis – over $7 Trillion dollars. The total cost originally made public was closer to $2 Trillion. Guess who received a majority of these funds? Banks!

    1. I don’t think it is only US and EU banking systems. Japan has had a problem for 20 years or so now in part because of the unhealthy close relationship between their banks and various industries although the Kobe earthquake anod now the tsunami earlier this year have not helped. The only ones who are relatively OK are the massive sovereign funded institutions in the Middle East backed by huge natural resources. And China of course which maintains an unhealthy link to the USD but even China is vulnerable if their main customers’ banks go down….

  3. I’m not fed up with banks I happen to use them for leveraging my real estate activities. Do I expect the government to do anything about it? Hell no. The only way the government will do something about is when lobbying money is no longer able to be accepted by politicians. Until then this game is run by who has deep pockets.

  4. An excellent use of the banks @YFS although even in real estate you would be doing extremely well to get the same real returns as banks while taking the risk that they don’t. In other words your loans from the banks will be secured on your real estate and if you get left with negative equity you will still have to bridge that gap of course!

    And yup, all governments are in the pockets of the banks as we showed in the Who Owns post some time ago. So it will be a very brave politician who foregoes support from the banks to change the legislation – possibly along the lines I have suggested before :razz:.

  5. If you ask me banks should be regulated. It is the only way that you can ensure fair ethical practices. In Canada we haven’t nearly the same issues people have had in the States because there are no “John Doe” banks. They are all corporate public organizations. I think family banks are the risky ones.

  6. I agree about regulation @Miss T. But the problem is how we get to where we would like to be or should be from where we are without the cartels causing even more mayhem. And in the UK, the mayhem was among corporate banks so I don’t think it is that issue. The big difference is probably that your banks have not taken to gambling so much. Canada has of course been doing pretty well of recent years with the $CAN moving from $1.6USD to about parity.

    But tthat is all why it will take political courage to implement. I will have some comments on the UK proposals next week … 😛

    1. It’s the ultimate isn’t it? It doesn’t come any better really, even winning a Nobel Prize, the Superbowl or Champions’ League! 😛

    1. Yup – the (banking) house always comes up trumps. So what are we going to do about it? Is there anything we can do about it?

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