The fundamentals of retail banking were probably devised about 5 minutes after the invention of money. It has been a business model that has remained relatively unchanged for centuries.
Simply the bank offers savers a return on any money deposited and then the same funds are used to source loans that are made at a substantially higher interest rate. Profits are generated by subtracting the difference between the interest paid to savers from the interest received from borrowers plus any overhead, as follows:
Profit = Interest from Loans minus (Interest paid to Savers + Overhead)
Admittedly this is an oversimplification. Payments are usually made on a monthly basis, but the principles are in place.
All too frequently, with the possible exception of the UK, banks charge private customers for their services and especially on current accounts. This seems to be doubly immoral from the author’s perspective because first and foremost customer funds are used to seed the bank’s profits and secondly next to no, or usually no interest is offered on such accounts. In other words money from current account holders is used to generate profits and they are charged for it!
There are of course times when the bank should charge their current account clients for banking services. The most obvious example being when a customer takes advantage of an overdraft facility – in this case the customer is actually borrowing from the bank and, as with any loan, interest should be applied. The bank can also legitimately charge for any abuse of the account, so long as the bank demonstrates transparency, clarity and a clear appeals process in its practices. Furthermore these charges should probably be punitive in nature, especially in cases of repeated offenses such as getting overdrawn or taking advantage of banking guarantees when knowingly exceeding limits
A great source of funding, in addition to customer deposits, has been the banks lending to each other. This was a crucial element that contributed to the severity of the banking crisis of 2008. When some of America’s biggest banks – for example Lehman Brothers – went bankrupt, funds that had driven the whole system dried up. Many banks had become so dependent on interbank lending, even to finance operations, that this led to a catastrophic meltdown. Coupled with bad investments and dropping share values the situation only became worse and bailouts were the only way to prop up the system.
Business Customers and Other Services
Banks also have the right to charge business customers for services provided, as these are additional services – beyond the basic – in accordance with the specific business requirements of the client. Banks also offer an additional level of security and protection to any funds held and safeguard against money laundering or other illegal activities. Banking fees, as expenses, can also be offset against profits for business clients to reduce their tax burden.
Why the Banks Don’t Want your Money!
However, for the main point I wish to make in this post, I must return to personal customers. We have already established that retail banking uses funds from users – or so the theory goes – to generate profits and all too frequently they are charged for this. The reality is that nowadays the banks don’t actually want your money!
How can I draw such a conclusion? How could such a situation have evolved so that in the ten years since the banking system almost collapsed and the banks were screaming for bailouts that everything has so radically changed?
The evidence speaks for itself and without too much analysis.
Firstly, the banks offer interest rates to savers that are substantially lower than the inflation rate. In other words keeping money in a bank account means that its value goes down in real terms.
You might as well keep your money in a sock under your bed!
Secondly, banks have to continue investing to grow and these funds must be sourced from somewhere. Banks generate profits on the basis of interest collected on loans as well as wider more diverse investments, for example stocks and shares. Funds can also be secured through interbank lending. With this in mind the sums don’t add up.
Most of the banks that were almost taken down by the financial crisis of 2008 didn’t return to profitability until at least 2016, or in some cases as late as 2018, as they continued to haemorrhage funds. So where did the capital come from?
It isn’t possible to draw any other conclusion other than the capital being used has come from the massive governmental bailouts, even if indirectly through interbank lending. So taxpayers’ money is being lent to taxpayers to generate banking profits that are turned into owner dividends and excessive bonuses for senior managers. The traditional way of generating profits for the banks was to use deposits to fund investments and generate additional income, but now – thanks to the bailouts – the banks have even found a way to bypass savers.
Now where is my sock…
© Richard Horton, Omega Support Services