I made a point in an article the other day about banks. Since then I’ve had a discussion with a few people about that article. I was amazed how their understanding of the banking industry changed after reading what I had written. So let me expand on those thoughts.
Most people think of banks as scary places into which they walk seeking a loan and fearing rejection. They feel as if when they go to a bank for a loan that they are begging. When you go into any other store to buy merchandise, do you feel like you are begging them to sell you something, fearing that they will reject your request?
Let me break this down. Banks are businesses. They are in the business of renting you other people’s money.
Think of it like going into a tool rental business. There on the shelf is a tile saw you need to install tile in your kitchen. You could have saved enough of your own money to buy a tile saw, but instead you decided to go rent one. The store has one for rent. The whole time you have it for your use you pay them rent on the tool. That is how that business makes its money.
When you return the tool and it goes back on the shelf it is no longer making them any money. Only when it is rented do they have a chance to make a profit.
But let’s say the tool rental store couldn’t come up with enough of its own money to buy all of the tools it needed to go into business. Let’s say they went out and talked to contractors and other tool companies and convinced them to let the tool rental company have some of their tools which they plan to rent out to customers like you. Under this arrangement they fill their shelves with other people’s tools.
But they have to pay rent on the tools they went out and got so they have to figure out a way to make enough from customers like you to not only pay the cost of their operations, and the rent on the tools they got from others, but they also need to make enough to earn a profit.
As long as the tools are just sitting around it costs them money. They only make money when the tools are out on rental. Do they ever really want them back? No, of course not. They would rather that you keep the tool rented forever and pay rent forever. That way they can pay their own rent to the other people, pay their overhead and make a profit.
Well what happens if the other people want their tools back? What if they all came in on the same day and demanded their tools? The tool rental company could only give back the tools on the shelves, the ones out on rental they could not give back.
Obviously the cost of replacing the tools would be too much for them to pay so they would have to close their doors and go out of business. The people from whom they borrowed the tools in the first place would be out of luck.
That’s what banks do. They get money from other people, pool it together and rent it (loan it) to you. Do they really want you to pay it back? No. They want you to keep paying the interest (rent). If you paid it back and they had it all on deposit they wouldn’t be making any money and couldn’t pay their own rent (interest) on the other people’s money.
What would happen if one day everybody who had loaned the bank money (put it on deposit) went in and demanded their money back? Obviously the bank couldn’t comply. All of that money is rented out (loaned). They would have to close their doors (fail) and the depositors would be left with nothing. (Well there is a government insurance fund, but not enough to cover everybody.)
Where do banks get the money they loan to others? Deposits such as savings, checking accounts, capital raised from the sale of stocks and the accumulation of excess interest earned over expenses. And they get a lot of money from the federal government, or at least they did in the past.
The Federal Reserve loaned them money at one rate and expected them to loan it out at a higher rate so they could pay the Fed its interest. The arrangement was so lucrative in the past that both the Fed and the banks kept getting more and more loans going between themselves. That system broke down and now the banks cannot get as much from the Feds as they used to. They can’t make as many loans as they used to. And they can’t collect from all of their borrowers anymore because the economy is doing badly; people are out of work and cannot make their payments.
Where does this leave depositors? Holding a paper statement. That was the point of my earlier article and the one I needed to reiterate.
Be careful how invested you become in the notion that “savings” is the safer course of action than spending. A good balance between the two will help the economy more than a good bank balance will.
Marcus Carey is a Northern Kentucky lawyer with 32 years experience. He is also a farmer, talk radio host and public speaker who loves history and politics. He is a prolific and accomplished writer whose blog, BluegrassBulletin.com, is “dedicated to honest and respectful comment on the political and cultural issues of our time.” He writes a regular commentary for KyForward.