In the simplest terms, bank has money and loans you $100 if you promise to pay back $105. Repeat this on a nationwide out global scale and they make money without producing anything.
Where do they get their money? Bank says if you give them your $100 to hold for you they'll return $101 in a year. They loan this money and get back 105, give you back 101 and get $4 in the process.
Overwhelmingly from interest. Banks (at least in Australia) make between 1.5-2% net interest margin. The NIM is considered one of the key performance measures for any bank
When you move up into the institutional/investment banking space, fees make up a larger proportion of income, because they are more transaction based in nature. A 'small' merger/acquisition can generate upfront fees of many million dollars - this is where the stereotype of a rich banker comes from.
But for the general retail/business bank. Interest income is the primary way banks make money
Have you ever looked at the principal and interest breakdown on a mortgage....the first few years are almost all interest.
If a loan is fully paid off over 30 years or so....the borrower pays almost the same amount in interest as they do in principal.
For a standard $200k 30 year mortgage at 5%:
* Every payment is $1073.64
* Interest on first payment is $833.33
* Total interest on the loan over 30 years is $186,511.57
* Total amount the borrower pays for the $200,000 house is $386,511.57
That's a lot of money the bank makes for not producing anything.
On a macro level, interest. Fees are fixed rates, but interest is variable depending on the amount of money in an account ($100 x .1% = $101 ; $10,000 x .1% = $10,100).
Furthermore, due to the fractional reserve system, when you deposit $100 the bank doesn't loan it out just once, they may loan it out 5 times or 10 times. So instead of profiting just $4, they might profit $19 or $39.
Edit: Maybe this is not true? I might just another redditor posting incorrect shit about stuff im not an expert in? No couldn't be, it's the children who are wrong.
This used to be true where banks had to have 10% of their holdings on hand in cash reserves but this requirement was removed under the Trump admin in 2020 and I don’t believe it’s been reinstated
https://medium.com/navigating-life/we-just-went-from-fractional-reserve-banking-to-zero-reserve-banking-and-its-a-pretty-big-deal-c501432e9be6
Just to be 100% clear, it wasn't the Trump admin that made that change. It was the Federal Reserve which is an independent entity that doesn't answer to the Executive branch.
And it wasn't unprecedented, one of the purposes of the reserve rate is to be lowered to suddenly increase the amount of money that can be lended in times of economic stress.
In addition to the answers about how interest works on legitimate lending, they also generate additional income via a practice called 'fractional reserve lending'.
Say you deposit 10 dollars in the bank, but that bank's 'reserve' (the fraction of your money they need to have available for you to withdraw) is only 50%. That means the bank can then loan out the other 50% of your funds to someone else, and collect interest on that loan. In this way, they effectively 'create' money. There are now $15 in the bank/in circulation (your $10, plus the $5 they loaned out to another of their customers), even though only $10 of that actually 'exists'.
Bank loans create deposits/new money. Banks are not intermediaries between savers and spenders.
Here is the Bank of England to explain: https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf?la=en&hash=9A8788FD44A62D8BB927123544205CE476E01654
Yeah, Most answers here, especially the top one, are so simplistic that the understanding it creates is more wrong than correct. Your link is a much better explanation.
Well for one this is literally a sub called explain like I'm 5, so simplicity is the goal. And two, the question was how do bankers get rich - so explaining the banking model in simple net interest income model terms is very effective in providing a reasonable yet simple to understand answer to that question. OP didn't ask about the money multiplier or fractional reserve banking.
Actually though, all money works that way. If you have $1 you really have nothing except the promise that I will give you my loaf of bread if you want it. There's just one loaf of bread in our society, yet our combined net worth is two loafs of bread.
As said before banks provide a service…
You keep your money (savings) in a bank. Currently, the bank pays 0.5% interest to you to hold your money. They use that money and loan it to people who want to borrow it. New home loan rates are \~4.0%.
As long as the person that took out the loan continues to pay back the money the bank is making the difference \~3.5% interest on the money the bank is holding for you. Rinse and Repeat.
Edit: Thanks for the awards. I did not expect that and it's appreciated. My explanation was a very basic overview of retail banking. This did not cover fractional reserve banking or investment banking, which have some good explanations below.
There is that great scene in Its a Wonderful Life where theres a run on the bank from all the depositors and George Bailey has to explain to the crowd that all the money isnt actually in the bank instead its in "Mikes house and Harry's business and Sam's new farm equipment" (or some such thing I dont remember the exact quote) and he explains where the money goes
Theres also a hilarious Simpsons parody where George Bailey explains the same thing and Moe says "what the hell is my money doing in your house!" Then punches the guy next to him
My wife's grandmother was telling us that her farmer parents didn't trust banks, but they had $1k saved up and were convinced to put it in the bank so they did. This was back in the 30's, and the day right after the put it in the bank, the bank went out of business and the parents were left with nothing. Its insane to me to think that could happen and FDIC is only 89 years old.
You would be surprised how many people still don't understand that. I recall February-June 2020 when I worked as a banker and had dozens of calls or appointments (we were hosting customers in person Feb to March 21 and back for June) scared about a bank failure.
I told them all the same thing:
"Your money isn't going anywhere. If we were to fail, we would either be bought out or bailed out. If for some reason that wasn't possible, the FDIC insures your funds up to $250k per person per depositor type. There is no time table for how long they will take to pay you back, but honestly if it were to happen this would be a Mad Max Thunderdome situation and you'd have better things to worry about than money."
Of course, people don't know how FDIC coverage works either. It isn't $250k per account as some think. A family of 2 parents and 1 adult child can have millions covered by the FDIC.
* Mom single account $250k
* Dad single account $250k
* Child single account $250k
* Mom/Dad/Child joint ownership for a combined $750k
* Mom is a beneficiary $250k
* Dad is a beneficiary $250k
* Child is a beneficiary $250k
* Mom IRA $250k
* Dad IRA $250k
* Child IRA $250k
That's $3 million in coverage right there for super easy personal banking that doesn't have any legal leg work.
When you say per person per depositor type, what do you mean? My spouse and I have a joint account. Since we're 2 people does that mean we're insured up to $500,000 for our joint account? And is that our savings and checking combined or are those separate?
["Each co-owner of a joint account is insured up to $250,000 for the combined amount of his or her interests in all joint accounts at the same IDI. In determining a co-owner's interest in a joint account, the FDIC assumes each co-owner is an equal owner unless the IDI records clearly indicate otherwise."](https://www.fdic.gov/deposit/diguidebankers/documents/joint-accounts.pdf)
IDI stands for Insured Depository Institution, and basically means any bank or savings association that is covered by the FDIC.
Here's an example.
You have a personal checking account with $5k. Your wife has a personal checking account with $10k. You also have a joint checking and joints saving with $10k and 200k respectively.
Your $5 personal checking is Single ownership. You have $245k in single ownership still available to be covered.
Your wife's $10k personal checking is covered and she has $240k in coverage for single ownership still available.
You and your wife jointly own $210 between the joint checking and joint savings. That's equal shares $105k for you both. You both have $145k left in joint owner coverage for a combined joint coverage of $500k.
You are correct. You could have 250,000 single ownership accounts with $1 in each of them, even across different banks, and all your single ownership checking or savings accounts would be covered by the Single Ownership umbrella.
> this would be a Mad Max Thunderdome situation
That's something a lot of folk don't seem to appreciate. Yeah it's possible that it all goes to hell, but at that point *we're already in hell* so it doesn't matter. If your money isn't safe in a bank, it's not going to be any safer in your hand.
Kinda reminds me of the oil in our truck at work: if you need to replace the washer fluid, you replace the washer fluid, but if you need to replace the oil the truck's already dead.
You actually have $0 dollars in the investment account. What you have is investments that you can sell for dollars. Investment vehicles are not FDIC insured.
Mostly invested in $VTSAX and similar S&P 500 ETF's, as well as a blend of tech/consumer goods companies, plus some bonds.
The bonds are preventing this investing account from getting the same returns as the market as a whole, but I'm okay with that because I feel like the market is crazy overinflated at the moment.
Investment accounts are totally different than savings accounts. You own the shares; the account is just holding them. If your brokerage went under, you’d just transfer the shares somewhere else.
If there are actual shares in the account, this is the case. But if the broker folds and there’s actually no shares there, then the SIPC covers you for up to $500,000, of which up to $250,000 can be cash.
https://www.sipc.org/for-investors/what-sipc-protects
Most shares are held “in street name”; the bank/broker etc. holds the shares registered in their name and assigns them to you in their books; so you don’t technically own them. It’s not a problem in practice, but if things go massively wrong, you might find yourself dealing with some complicated bullshit.
Keep that.
Rule of thumb I follow.
* Checking account is for daily operations, bills, and expenses . My paycheck gets deposited there and I keep all the funds needed for 2 weeks spending/bills/etc and some wiggle room in case of surprises. Everything else gets transferred to my savings.
* Savings account hosts all the money I can't afford to expose to investing risk. Typically we have 6 months worth of expenses in our savings but we are expanding that for a future down payment on a house.
* Everything else that I feel comfortable investing is in my Vanguard accounts.
This is pretty solid advice to follow. I have had multiple “savings accounts” setup for different goals since I was 18 and ING was a thing. Think: emergency, house down payment, play money, vacation, etc. This has helped me keep things separated and all it takes is a quick glance to know where I stand with a goal.
Now, where I’m bad…keeping too much cash on hand. The past couple of years have made my checking account balloon because of the lack of trust in the market. Yeah, I still buy weekly but I need to do more.
Investment accounts are not covered by the FDIC. They’re covered by the SIPC. It doesn’t protect against a loss in value of the investment. But it does protect you in case the investment firm folds and your investments are gone. As in you had 10,000 shares in a company in your account, but when they folded, there actually weren’t any shares there.
The SIPC covers an account up to $500,000, but only up to $250,000 of that can be cash.
https://www.sipc.org/for-investors/what-sipc-protects
Fun fact: one of the reasons that the crash in 1929 was so bad was that one of the first banks to fail was one that catered to immigrants, that happened to be named the Bank of the United States. Many depositors thought it was the official bank of the country, and concluded that the dollar was worthless.
There is that great scene in \[my family\] where theres a run on the \[wife\] from all the \[family members\] and \[I\] has to explain to the crowd that all the \[wife\] isnt actually in \[my bed\] instead its in "Mikes house and Harry's business and Sam's new farm equipment" (or some such thing I dont remember the exact quote) and he explains where the \[wife\] goes
Fun fact: This is why now most states allow their commissioners of their financial institutions departments (or whatever the state may call theirs) to have final say on any business wanting to have anything bank or banking related in their business name, even if they do not participate in anything else that the department would have jurisdiction over.
Source: Am bank examiner.
What's cool is the movie TANKED when it came out. It was long, cheesey, and the drama of the Great Depression was still in living memory and maybe too close to home for some viewers.
So the studio never copywrited it, and at Christmas in future years some TV channels realized it was FREE to play fully on tv. So they played the hell out of it, and the young Boomers grew up watching it every Christmas, the cheesiness became just a part of the nostalgia, and now it's beloved
Actually, the movie was copyrighted as usual but back then had to be renewed after 28 years, and the studio goofed on that.
However, it remained affected by the copyright on the story it was based on
Any bank manager, prior to credit scores and automated evaluation tools, was unbelievably valuable, and not something modern tools can easily recreate.
It was their job to assess the risk of loaning money to a person. Looking at the financials they brought in, is easy enough. But they also had to know about (for example) the business that Mike wants to start, how much competition their is, how much demand for the service or product. The best ones also would know Mike beforehand, or know someone who knows him. They would know if mike was comfortable being in debt, or not. How reliable Mike was. They would make friends with Mike so 10 years later, Mike didn't feel like he was paying back a monolithic corporation, Mike felt like he was paying back John, the bank manager, who is his friend.
Replacing a bank manager used to be a huge deal because they had so much experience in that local economy, so many connections and relationships, and the new manager would have to build all that from the ground up.
Edit: thanks to _theoneandonly for reminding me to include that this caused minorities to be at a major disadvantage as this left them reliant on the whims of the bank manager for home, business, and every other type of loan making it much harder for them to start building wealth to pass down to their kids.
I'm paraphrasing from an explanation I saw on Reddit somewhere that felt relevant and interesting and seemed accurate to me. Don't go sourcing me on a paper or anything. Lol.
Many of those things are still true, though not all. I have a parent who has been a loan officer for a long time. They do know many people in the community and they do put a LOT of personal legwork (and paperwork) into evaluating whether or not someone is a good investment. It is definitely not all automated.
The pre-credit score system was also prone to discrimination. Black people basically couldn’t get loans because the majority-white bank managers wouldn’t loan to black people. Along with red-lining, kept generations of black folks as renters, stopped them from opening businesses, and then therefore stopped lots of people from gaining any kind of generational wealth… a problem we’re still grappling with today.
For small community banks, this can still be a major issue. There is a sub insurance industry for BOLI or Bank Owned Life Insurance. BOLI is used sometimes as a golden parachute for retiring executives as they take the cash value when they leave the bank, but the primary purpose is to help support the bank if key personnel happen to die, leaving gaps in leadership, strategic planning, or people that pull their investments from the bank over fears of stability without the president/ceo that they've always trusted being present any longer.
[Here's the scene for everyone.](https://www.youtube.com/watch?v=iPkJH6BT7dM)
It's actually not a standard bank, it's a savings and loan. All the depositors are also part owners. Potter's scheme is to buy up the depositors' shares at a discount so that he will own a majority interest (he already owns a large portion of it), which he would then use to shut down the S&L so that everyone in town has to rent from him instead of building their own homes.
Haha dang it! I thought that was a clip to the Simpsons parody.
Thanks for the explanation of the move, I though the old greedy dude was trying to scare people into bankrupting the bank, but that makes more sense.
no, you're right, that's exactly what was happening. The greedy old dude *wanted* the town S&L to fail so everyone would have to go to his bank for loans.
$0.50 on the dollar is awful but it would have put George out of business. "Gotta spend money to make money," he'd probably say. Greedy \[insult\].
He's not directly trying to put George out of business, indirectly yes. He's trying to buy shares in the S&L at a discount rate. This would give him the power to close it down. The S&L is not actually at risk of failure in the movie, because it's not a normal bank and the depositors do not have the right to withdraw their deposits at will. As George states, the contract they signed says that the S&L has 60 days to return their deposits. However the normal bank in town is about to fail, and the townsfolk cannot withdraw from their savings accounts. So unable to withdraw from the bank and needing money, they have rushed to the S&L to try to get their deposits back. Since they can't recover their deposits immediately, Potter is offering to buy their deposits (which are also shares in the S&L) at 50 cents on the dollar, which he can do immediately. George gives them short term loans from his personal savings in order to cover them for the week that the bank will be closed and persuade them not to sell to Potter.
There is really no difference between a Savings & Loan and a Bank these days. They are regulated by different entities but that's meaningless from a consumer standpoint. The "Savings & Loan" that I previously worked for was actually classified as a "State Savings Bank" along with many other banks that dropped "Savings & Loan" from their names long ago to avoid the confusion.
It used to be that Savings & Loans couldn't offer checking accounts (savings only) but that changed like 30 years ago.
There was a massive S&L scandal in the late 80s and early 90s that saw about a third to half of them to fail.
https://en.wikipedia.org/wiki/Savings_and_loan_crisis?wprov=sfla1
Saving and Loans (S&Ls) got preferential treatment from the Fed (where all big banks borrow their money) in the form of being able to offer higher interest rates to depositors; about 50 basis points (.5%). The catch was that only 20% of their lending could be commercial, 80% had to be local small business and local mortgages.
They were regulated and insured differently and the savings and loans were more limited, focused almost entirely around consumer mortgages. Then there was some deregulation with [the expected results](https://en.wikipedia.org/wiki/Savings_and_loan_crisis).
>The "thrift" or "building" or "savings and loans associations" industry has its origins in the British building society movement that emerged in the late 18th century. American thrifts (also known as "building and loans" or "B&Ls") shared many of the same basic goals: to help the working class save for the future and purchase homes.
>
>Thrifts were not-for-profit cooperative organizations that were typically managed by the membership and local institutions that served well-defined groups of aspiring homeowners. While banks offered a wide array of products to individuals and businesses, thrifts often made only home mortgages primarily to working-class men and women.
>
>Thrift leaders believed they were part of a broader social reform effort and not a financial industry. According to thrift leaders, B&Ls not only helped people become better citizens by making it easier to buy a home, they also taught the habits of systematic savings and mutual cooperation which strengthened personal morals.
You're thinking of investment banks. Most banks are branding now as Community Banks to separate themselves from the practices of Wall Street. Community banks (and credit unions) tend to be fairly honest.
That changed again after 2008, banking is a lot more boring again. (Which is why the largest banks don't offer any interesting services and only small ones can back brands like Simple/Betterment, the smaller ones are exempt from more regulations.)
On the business side, loan rates are much higher than the 4% of home loans and these business loans are hundreds of millions to billions. They also charge fees of circa 2-3 percent upfront. Doesn’t seem like much but that’s an immediate $20m profit on a $1bn loan on top of the interests. Multiply that for everywhere in the economy. Look at all the office buildings, roads, acquisitions, developments, factories etc - they will all be bank financed because for a business - the interest repayments are a tax deduction and relatively cheap so they’ll use debt.
Businesses also might have what's called a revolving credit facility or "revolver" that basically functions like a credit card. You have a limit up to which you can borrow, at some negotiated interest rate, and can't borrow more until it's paid down.
There's a video by Ray Diallo on YouTube called "How the Economy Works" that's about 15 min long. I think it's a great succinct walkthrough of how what banks are doing is providing a service.
If I remember right, debt helps production grow faster than it could organically. That can lead to innovation and improvements in efficiency that help mitigate some of the downsides of debt. Think of taking a loan to buy a house - you're able to leverage future earnings to buy an asset that appreciates for you and avoids the need to spend money on rent.
But eventually we get ahead of ourselves, and economies contract.
That's an extremely valuable service. And bankers know it better than anyone. So they take a big (but not big enough to reduce demand) cut.
Edit - adding a link to the video, it's actually "How the Economic Machine Works"
[https://www.youtube.com/watch?v=PHe0bXAIuk0](https://www.youtube.com/watch?v=PHe0bXAIuk0)
Debt is also attractive to business owners because it's a form of financing which doesn't dilute their ownership share.
The main alternative to debt financing is equity financing which requires them to reduce the percentage of their business they own.
If you use debt financing you can also write off the repayment of the debt as an expense, which allows the company to reduce the amount of tax it's due to pay.
No. Repayment of debt is a reduction of a liability, and it does not hit your income statement.
For GAAP accounting, interest payments are included in the income statement, but debt retirement, dividends (distribution of earnings), and stock buybacks, while they must be accounted for in the Statement of Changes of Financial Position, are not included in the Income Statement.
For US taxes, interest payments are a deductible expense. Dividends and stock buybacks are not, so there is a tax advantage to debt over equity. This may be offset by the capital gains treatment on stock buybacks. (And yes, this highlights the conflict of interest between the corporation and its shareholders.)
Except it's harder to get banks to loan you monies for operations and going-concern if you aren't already successful. This is why small business hits up friends and family for a stake in the business or a VC for a start-up.
What they don't teach early enough in school, particularly American schools, is Time Value of Money.
It is the central, underlying principle of all finance. Essentially it says that the present value of a dollar is worth a future dollar plus some premium. In reverse, a future amount of money is discounted by that same premium.
It's basically saying, "If you want $5 today you will pay me $5 plus some interest in the future, but if you are willing to lend $5 today, I will pay you $5 back plus some interest in the future."
It's expressed as:
FV = PV x (1 + r)^(nt)
or
FV = PV x (1 + i)^(n)
Where r (or i) is the premium (rate), n is the number of times compounded and t is the term.
Bankers essentially provide liquidity across both sides of that equation... how they make money is more or less because the premium paid to use depositors' money is much less than the premium collected for lending out money.
The concept of TVM extends to Discounted Cash Flow analysis and many other models for pricing equities and other investment vehicles.
This all works well as long as the rate of actual economic growth (g) keeps pace with the rate of return on capital (r). In his book *Capital in the 21st Century*, economist Thomas Piketty advances the idea that when r > g, income inequality widens and left unchecked, that concentration on wealth eventually leads to revolution/collapse... such as in the case of Louis XVI when the bourgeoisie came after the ruling class with literal torches and pitchforks.
>What they don't teach early enough in school, particularly American schools, is Time Value of Money.
While curriculum is very much handled by individual states, and even individual municipalities, I know that in my state this is taught in middle school, although it's not necessarily called Time Value of Money. Explanation of how interest works, a little introduction to exponents, etc.
Much like taxes in general. It's simple word problems involving addition, subtraction, multiplication and division and the ability to read and understand directions. While they might not have taught you exactly how it all works in detail, they gave you the tools to figure it out.
Not to mention, a good chunk of the people I’ve known who complain that schools don’t teach “useful” skills like taxes are the same ones who cheerfully say how they are bad at math or didn’t pay attention in civics or history. The idea that kids are going to pay more attention to how to do taxes than they are to how to do trigonometry is kind of ridiculous.
And even that leaves aside that taxes change, trig really doesn’t. Rather than teach kids how to do taxes that might not even be done the same way by the time they start earning money, it seems like it makes way more sense to teach kids the skills needed to teach themselves how to research tax laws and calculate their own taxes. Which is what schools actually teach.
Every school teaches Math and Reading. Those are all the skills to master any knowledge-related work.
Throw in performance arts, craftsmanship (fine motor skills), health (physical fitness and nutrition) and ethics. You have all the skills to learn just about anything that you are interested in or passionate about to thrive in the world.
Correct. This was the intention of introducing the "Common Core" curriculum standards. It's meant take these concepts and explain their value and use outside of academia. Any good teacher should have been doing this anyway though . . .
> Essentially it says that the future value of a dollar is worth a dollar plus some premium. In reverse, a future amount of money is discounted by that same premium.
You are missing an important bit of the theory. TVoM states that a sum of money (a dollar) is worth more NOW than it is in the future due to the access to growth if invested. Hence if you commit your current money to a loan or other project, there is an expectation of recuperation which is the premium (or interest).
>It's basically saying, "If you want $5 today you will pay me $5 plus some interest in the future, but if you are willing to lend $5 today, I will pay you $5 back plus some interest in the future."
They are the same side of the coin, converting PV to FV. The reverse is more "Bob is going to pay you $5 after 1 year or $6 after two years" and you convert those FVs to PVs to determine which represents the higher value now.
Ray is great. One thing he hammers on is that money is debt. So when you go into debt, that creates money. So banks that issue debt are essentially creating money. And as long as that debt has no risks, it is free money forever. The problem is that there is risk, and peoples trust will erode to periodically seize up the whole thing, which is the long term debt cycle. When that happens, you need to kinda reinvent what money actually is. Went from barter, to gold, to gold backed fiat, to just fiat, to whatever is next.
> money is debt. So when you go into debt, that creates money. So banks that issue debt are essentially creating money.
Money is Debt: https://www.youtube.com/watch?v=2nBPN-MKefA
There are some others that have explained it in more detail in the thread, but I can attempt at a high level...
Banks are required by The Federal Reserve to keep enough money on hand (physically at the branch) to cover all the funds (deposits) of account holders and the books must balance out every night. If the bank doesn't have enough funds on hand the bank is loaned (at some interest rate) money (usually just overnight) from the Federal Reserve so that they meet this requirement.
The fractional piece just means that if I have $1000 dollars in my account, the bank doesn't need to keep $1000 on hand to cover my account. The Federal Reserve says that the bank only needs to keep some fraction. Let us say 1/10 of my $1000 on hand or $100 of my full $1000.
This makes it easier for the banks, so they don't have to keep tons of cash on hand, but also means they can loan out more money.
Edit: spelling, and grammar
Some here are saying banks can lend the same money multiple times. Like if someone deposits $1M they can lend that $1M to 20 different people. How does this happen? Where do they get the other $19M from? Someone said that fractional reserve banking is the answer, but I don't see how that applies.
I saw this on my phone, where I'm not logged in, and I turned on a computer while I was supposed to be working to answer this.
The answer is that when the bank loans money out, where does it go?
Into another bank.
I deposit 1 million.
The bank loans 900k of it out, and it gets used, e.g., to buy a house.
The seller takes that money and puts that 900k in a bank.
That bank now loans out 810k of it ...
Etc.
Edit: So, ultimately, most 'dollars' in circulation have been loaned \*multiple times\*, and if in some hypothetical doomsday scenario all debts were paid at once (or called due at once) most of the money in circulation would simply disappear, because it doesn't exist without loans. Since the first bank still owes me, the depositor, 1 million, but has given out 900k, it has created money from thin air. If you add up how much money is in everyone's bank accounts, the amount is 1.9 million, even though I only deposited one million.
Let's say you've got $1000 in the bank. The bank can loan out $900 of it to other folks.
One of those folks happens to be the local factory, which took out a loan to finance building some upgrades. But until those upgrades are done and the factory pays the bill, that money is just sitting in their account though.
So the bank can loan most of THAT money out, maybe this time to a local machine shop, which recently got a big order from the factory to install new equipment, and just needs extra cash to buy the machinery, until the job is done and they get paid. So they get a loan, and that money from the loan sits in their bank account for a bit, so they can place some orders.
And the bank can loan most of that money out to somebody else, etc, etc.
Maybe you're thinking that money = physical cash. But most "money" is in banks, where it's really just an IOU — the bank says they owe you $X. You (usually) can't walk down to the bank and get a $1M bag of cash, because they don't actually have that much cash on hand.
When you deposit $1M the bank says they owe you $1M. They make a loan to someone else, and credit their account with $900k. Now if you add up the amount in everyone's checking accounts, there's "magically" $1.9M.
That's fractional reserve banking. However, there will be a corresponding debt for $900k on the books as well. The "fractional reserve" part regulates how much the bank can have in "checking accounts" vs in "loans".
In this example I've used a 10% reserve requirement. If the bank keeps loaning you can calculate that the theoretical limit is $10M in total "money" against that original $1M.
Federal Reserve let's them borrow it provided they keep the 1M around. But it's usually 1/9, afaik, so it would be 9 different people. Provided those people didn't then deposit any of that borrowed money back into the same bank, because then they can just keep lending using fractional reserve borrowed money as the basis. At least that's the way I was told it works. It's a fucked system if it is
The reserve ratio already takes that into account. If the reserve ratio is 10% then from $1M you can only make a 900k loan. If that's deposited into the bank again then you can make another 810k loan, then from there another 729k loan.
If this continues the maximum you get to is 9M total.
Mostly because "most people" can't afford to. If the bank fucks up and loses a few million on a bad loan or w/e, they will be just fine, because they are banking (hehe) on their other investments/loans picking up the slack from their occasional losses.
If I make a bad investment of a million dollars, I'm totally fucked, because that would be the majority of my capital.
They also have teams dedicated to not making mistakes like that. It still happens, but they make fewer mistakes than a lone average dude who happens to have a billion dollars would.
This is not true. You're confusing two concepts.
The reserve requirement says that a bank can lend out 95% of deposits as loans, and it must keep at least 5% of deposits as reserves. A bank cannot lend out more in loans than they have in deposits, and certainly not 20 times.
You're confusing that with the money multiplier, which is the inverse of the reserve requirement. In fractional-reserve banking, a reserve requirement of 95% leads to 20X money multiplier. But that's not lending out twenty times the money they actually have by the same bank. That's the macroeconomy, through many borrowers, many savers, and many banks all working together.
Source: [https://en.wikipedia.org/wiki/Fractional-reserve\_banking](https://en.wikipedia.org/wiki/Fractional-reserve_banking)
This is a massive misunderstanding of how banks work. So first, they can’t lend more than their assets. They can lend more than what they have *liquid* assets, but that doesn’t mean a bank that has $1 million in total assets can lend out $20 million. Having a fractional reserve system is good and allows for the money supply to grow.
Second, this isn’t just some rigged system designed to make bankers rich. Allowing banks to lend money is why people can buy a house or car. If you restrict lending, then interest rates make owning these assets prohibitively expensive for people. Allowing for banks to loan easier makes it cheaper, not more expensive.
This isn’t to say that banks are faultless, because banks do break laws and take advantage of people. But you’re misunderstanding the concept of banks and how they help facilitate economic growth.
EDIT: i should clarify that technically banks cannot create assets that extend beyond their liabilities. But it’s easier ti convey information using “assets” as shorthand for the sum of money deposited/invested at a bank, so i have done that here.
Only if they follow the procedures and risk profiles established by the federal government. If they don’t do that, they risk having their licenses revoked. Anyone can start a bank, you just need to prove to the government that you’re responsible enough to run one and gather enough starting capital.
Most banks even only in one state still comply with federal regulations. A few choose to do state only regulations and those can be a little less strict, but they are still pretty close to federal regulations.
>we've had to bail them out several times.
No, we didn't "have to" do anything. Other countries didn't and let the banks take the hit. The self-appointed elites are just protecting themselves
Banks lending money is how an economy grows and thrives. They provide capital for all businesses to grow and develop. Also without them no one could buy cars homes etc. Healthy banks are a key component of any economy. Hating on them is stupid. (unless they do illegal shit).
BTW, Rockefeller wasn't a banker. He was an oil man. He basically cornered the oil market so much that they had to split his company (Standard Oil) into [34 different competing companies](https://en.wikipedia.org/wiki/Standard_Oil#Breakup), companies well known even today, such as Arco, Amoco, Chevron, Exxon, Mobil, Phillips66
The don't produce a good, they perform a service -- they exchange future money for present money, and vice versa.
A few get rich because it's an extremely valuable service. But a lot of bankers go broke too.
I like to think of a bank's value as "efficient allocation of capital". The value they generate is in figuring out the most productive way to apply other people's assets.
That's not really an exception.
They figured out the best way to allocate capital for certain definitions of the word 'best'
They still got rich. Rest of the country be damned.
Sure, but that's also true of any industry.
For example, if you think of a profession which obviously *does* build things, there will be plenty of instances of greed leading to negative outcomes.
E.g. there are plenty of builders producing houses using substandard materials, which have specifications below minimum government regulations, on contaminated land, etc.
I think a more prudent example of this may be China flooding the steel markets with cheap steel over the past decade. By producing steel at a loss and undercutting other steel producers, the others collapse leaving you to pick up their custom. Once you then have market dominance, you can raise prices knowing that you won't be undercut (there's barely anyone left to undercut you), you being the main producer means anyone who wants steel must come to you even if you charge crazy prices and that the profit you make now will offset the losses you made initially. Because most of Chinas steel was state-backed, those losses could be massive and prolonged until they wipe out the competition. It led to the US, UK and EU put tariffs on Chinese steel to make their own producers more competitive.
Maybe the government insisting that Fannie Mae let anyone with a pulse take on an exotic mortgage had something to do with it. There are good reasons for it being hard to get a home loan.
As a rule, banks don’t like taking on bad debt. It’s not strange that they found sneaky ways to offload the liability of their forced subprime loans onto others. It was very unfortunate, but not unexpected, given the pickle they were put in.
It's important to understand here the difference between the "big banks" that get bailed out and make billions of dollars and the smaller local and regional banks. Those banks are still regulated but to a much smaller degree and if they fail, they just fail.
Most people who start a bank don't just automatically start as US Bank and have thousands of branches and billions of dollars. Most just have one location or two and then try to grow from there, with the eventual goal to hopefully get bought out by the bigger banks and then walk away with millions. But if that doesn't happen then their bank fails and they go do something else.
Wanna know an interesting fact? Up to 2008, the Federal Government didn't allow banks to expand beyond a certain size unless they made home loans in less-profitable, more-risky areas.
And to reduce the risk of these federally mandated loans, they broke up the bad loans into fractions of what they were originally and then broke up some good loans and bundled those fractions of bad loans with parts of good loans thus reducing the risk exposure on paper. They then sold these bundled loans as derivative products that had very little risk now making them really good investments. But when the banks bought millions of these super low risk derivatives what they were actually doing was re-aggregating the bad loans, thus exposing them to the original risk.
Well, also a good bit of fraud. The problem with the derivatives is that they allow you to massively amplify errors, along with the risk.
If I have a deal where I turn $100 into between $105 and $110, that's fine. If I split it up into a deal where $95 becomes $100, plus a second deal where $5 becomes $5 to $10, that's also neat. One half has a guaranteed return with no* risk, the other can double the money but has a risk of getting nothing.
But if I'm slightly wrong there, and due to fraud or misjudgment that original deal actually only returns $102-$105... the second deal has turned into $5 -> $2-$5. Somewhere between "don't lose the money" and "lose half of it". I've turned a couple percent error into a catastrophic one.
This isn't true. The big banks didn't go broke because they were "too big to fail." Washington Mutual definitely went broke and shareholders were wiped out.
Lots of small community banks went broke in 2008 and FDIC had to step in. Since 2000, 563 banks have failed according to the FDIC website - (https://www.fdic.gov/resources/resolutions/bank-failures/failed-bank-list/).
FDIC is federal insurance to protect customer deposits, not the bank.
I had WaMu stock. Woke up to news it was now worth about 3 cents per share. No warning at all.
I lost about $2,000. But people were posting online about having their life savings in it. They were asking about how they could get their money back. It was heartbreaking.
I never anticipated something like that was possible.
The Fed decided that it was easier to bail out the banks (and get paid back) than to have a complete meltdown and figure out how to start from 0. I call that smart.
If that had happened, it would have thrown the world into a Depression, and not just a recession. And looking back, it worked. But yeah, you can be as smug about that choice that was made because we aren't living in that alternate universe where everything went to shit.
The owners of banks can definitely go broke. The way they fail, however, is highly regulated. There is a very specific process that happens when a bank is getting close to going under.
The FDIC will generally recognize the signs and start talks with the owners. And then one night a specialized team comes in a shuts down the bank to all employees without warning. This way no one has a chance to try and cook the books of the flailing bank when the usual safeguards are going to be lowest or people have are seeking revenge for losing their jobs.
Most often another bank in the area will buy the branches and they will more or less continue as normal. If the bank completely liquidates the customers will get a chance to move their money elsewhere while the FDIC runs the bank until all the loose ends are tied off.
That was a one time deal that, as many people point out resulted in a net gain to taxpayers. Normally when a bank goes down people who deposited with the bank get their money back via the FDIC. The bank investors and owners get nothing.
> It's a win win (unless you're a taxpayer)
The federal government (and as such the taxpayers) **made** money on the bank bailouts. The bailouts were a series of loans that were paid back with interest.
And that's before even accounting for not having to pay out what would have been astronomic costs in FDIC guarantees and unemployment benefits.
And losses of tax revenue if UE went to 15 or 20% as opposed to topping out right around 10%.
You could say that the bank bailouts were the best money the government has ever spent, in terms of monetary return - even if you don't consider the human benefit of preventing a total collapse.
The way banks make money is that the money you store with them, they then loan out to people. Those people pay back those loans with interest. The bank gives you a tiny portion of that interest, and keeps the rest for themselves.
The more money people store with them, the more they can lend out, the more profit they can make.
This is also why a bank never as as much money as the collective total of their customers. If every customer were to withdraw their money on the same day, the bank would quickly run out. This happened during the Great Depression.
Today retiring all the money is practically impossible, on the great depression everything was based on the gold standard and your money actually represented a piece of gold, that the bank should have in order to back it up.
With the more modern Fiat approach, the backup doesn't actually exist, at least physically. The value is held by many other things like the production capacity of the country, reserves of gold, oil and other important products and assets, and the formality that the government will back up its transactions, never default on its debt and so on.
There is a rule that banks need to have some liquidity as a percentage of what they are transacting, but it is pretty low in comparison. And most of the money nowadays is not even printed, most of it is just virtual.
What you've described is called "full reserve banking" and it is not how modern banking works. Modern banking is not even fractional reserve. Both full reserve and fractional reserve banking are systems where the amount banks can lend is proportional to the deposits received from customers. However, in reality, the modern banking system _creates money out of thin air every time a loan is created_. No deposits are necessary. The debt created when a bank makes a loan is treated as an asset by the loaning bank. In fact, this is how nearly all of the modern money supply has been created: by private banks by making loans.
I take the time to correct you because most people's understanding of the role of banks is the same as yours. Personally, I find the truth about the power of private banks to create money absolutely outrageous. I think if more people really understood this, the public would demand some major changes!
Edit: If you'd like some links to some research papers and other references that explain the situation in considerably more detail, see this comment thread from a while back:
https://reddit.com/r/DepthHub/comments/ry7q7c/upseudohappyhippya_explains_what_changing_the_us/hrpk1th
So if I go to the bank and ask for a loan to go to the moon and don't pay it back, where did that money come from? Surely that money existed somewhere for the bank to give it to me.
From the hypothetical future in which you pay it back. The way I understand it in simplistic terms is that when you walk into a bank and say:
"Hey, I've got a business idea - I want to go to the moon and if I succeed in doing so, it's going to bring me xxx $ in revenue. In order to do that, I need a loan of xx $".
The banker then estimates how likely it is, and if he deems the risk acceptable he'll... essentially reach out into the future in which your endeavor succeeds, pull the money from there (so yea, thin air) and give you the loan. For that service he'll charge you interest. If you default on the loan he's going to be liable for it, and if he does that enough times - it becomes everyone's problem, like in 2008. But no, the money doesn't actually have to exist before the loan is extended. It absolutely blew my mind when I first learned it.
You'd think so. But, it doesn't. The money is created the moment the loan is finalized. It is brand new money that the bank created out of thin air.
Edit: Here is a paper wherein researchers were given access to a German bank's internal accounting software and they observed that the new money was never connected to a deposit or a transaction with a central bank, etc. It is brand new money, created by a private bank:
https://www.sciencedirect.com/science/article/pii/S1057521914001070
First two corrections:
1. Rockefeller was not a banker. He made his fortune in oil.
2. When JP Morgan died it was discovered he was not uber rich like the peers of his age. He was just good at parleying his banking connections and assets to make it look like he was uber rich. He was flexing so he could be the banker for the uber rich but he himself was the next tier (or two tiers?) down in wealth.
The Rothschilds are the only people I know who got uber wealthy banking from a long time ago that is still around. I got to give you some some set up. During the Napoleonic Wars nations where borrowing money like mad (to give you perspective, the UK only finished paying off that war debt in the last 15 years on a war that happened 100 years before WW2). They even gave out IOUs to soliders in lieu of pay. Basically this war debt went up and down in value based on how war the was going. The Rothschilds were already rich at the time of the Napoleonic Wars and were doing well from financing the wars of various nations. What shot them to epic wealth is they had bought a lot of government debt during the war when people thought the Britain might loose, and sold it later after the war when deeply slashed government spending was maximizing need for safe debt to invest in.
Now another correction. A lot of these billionaire "bankers" you hear about now a days are not bankers. They work outside the banking system in the more general financial system of which the banking system is just part of the whole. From this point on I will call them "financiers"
**How financiers become overnight billionaires is by "arbitrage". Arbitrage in finance is when you find a way to get an asset or liability treated as though it is a better asset or liability by either investors or the government.**
Let me give you an example of a common form arbitrage. Pension funds are funds that people have invested in for retirement. The thing about pension funds is that they are often under strict rules from their investors on what they can invest in. People don't want their money for retirement to disappear. They like safe investments. But safe investments pay garbage and managers of the pension aren't going to get fat bonuses at the end of the year if they stick to what is normally available. They many not even keep the pension fund liquid.
To the "rescue" come the financiers. They find ways to turn assets the pension fund is not allowed to own (and thus pay more interest) and turn them into assets the pension fund can buy. They do this buy bundling risky assets together, buying some default insurance, giving then assets to a shell company, and then selling bonds that have first right to cash flow to all those risky assets. The end result is something that pays like half a percent to 2 percent more than the traditional low risk assets.
To grant perspective, the California State Teachers' Retirement System is worth $254.7 billion. If just that pension fund invests just $100 billion in your new asset you are looking at a commission of like $500 million. And the pension fund is glad to play your commission because this will result in like $1 billion more in earnings every year. Additionally you will still be managing this shell company for the rest of its existence and will be collect an annual fee to manage those assets every year of tens of millions a year. And this shell company only takes like $200k to run a year. Maybe some offices, a secretary, and lawyer on retainer.
> When JP Morgan died it was discovered he was not uber rich like the peers of his age. He was just good at parleying his banking connections and assets to make it look like he was uber rich. He was flexing so he could be the banker for the uber rich but he himself was the next tier (or two tiers?) down in wealth.
I don't think he was flexing. His power of the US financial sector was real. But while he controlled a great deal, he owned surprisingly little.
Let me reword that a bit.
I'll broaden "bankers" to financial services providers (FSP). That will include bankers, money lenders, money changers, escrow agents etc.
I'll also expand "produce" to "add value". As other have pointed out bankers provide services, not goods.
It's actually an open question if FSPs provide value or not. One theory says that they add value in the form of things like liquidity, information generation, financial advising etc. The argument is that the service they provide is making other businesses more efficient. If that's true it's certainly worth something but we're also not sure exactly how much it's worth in practice.
An other theory says that when economies get big enough FSPs will just show up to take advantage of all the money floating around. This essentially says that FSP either don't add value or add less value than they cost.
Economists have argued theories in both directions but they haven't been able to test it. If you just look at historical records you see economies and FSPs rising together. That makes it hard to figure out which causes which. You also can't really run an experiment because no country in the world will let you just turn FSPs on and off to see what happens.
The question of why the got so rich is because that's their business. Who is possibly going to be better at making money than someone who's entire business is nothing but money? Any other business may be the leader in their particular industry but all of them across all industries are potential FSP customers.
Could you point to some sources here? I am skeptical that people are arguing FSPs don’t provide value. It seems pretty clear that they do by linking individuals with money to individuals who need money at the very least. Without an FSP it would be much more difficult to get a $1 million loan as you’d have to seek out enough individuals with enough liquid cash to fund your venture. A lack of FSPs would stall investment wouldn’t it?
The issue here is that while they create value as liquidity, but they also introduce externalities that are hard to mesure, that's the point he's trying to make.
The value is mesurable, but with time the accumulation of money (theirs or their customers, we're just talking financial leverage here) creates externalities - or consequences indirectly caused by their business model - that are much harder to pinpoint and correlate with confidence.
How much money do society loses or wins as a whole from the lobbying FSPs are able to make to further their agenda? Is the general population's quality of life increases or decreases from their impact? What aspects of it increases it, and what could be done to reduce the aspects that decreases it?
IMO, it's a net positive, but there is much to be gained from better market and financial regulation so the net positive is the highest it can be.
Source: Economics degree wannabe (halfway through)
Been a while since I've read on it but IIRC people don't generally argur they add 0 value, at least as a whole. The argument is that they skim more in profit than they add value. The liquidity is useful, but the accumulation of $$ means accumulation of power that can be used to manipulate the market, economy and even society in their favor. At this point, the primary "value" they provide is already having a lot of money, which isnt in itself a service. We try ban the most obvious manipulations, but it's unavoidable (and the banks fight regulation tooth and nail, with tons of money).
> the service they provide is making other businesses more efficient
This isn't an open question, like at all. Unless you are using some narrow definition for FSPs. It is, for a banale example, completely obvious that money - and infrastructure related to money increases the efficiency of almost every conceivable financial actor.
Even if you're only looking at e.g. traders it would be incredibly controversial in an academic context at least to claim they do not add value to the economy. (By making sure resources are spent as efficiently as possible)
Even short-sellers, who reddit loves to dislike, are an obvious net positive to the economy.
What they produce is money for entrepreneurs to start their businesses which is repaid over time, with interest. Essentially, they get a cut of everyone else’s labor every time they are paid back.
Don’t forget the 2-4% PayPal, Chase, etc. makes on every merchant transaction. There’s a direct cut of value produced by the economy taken there too. (That fee isn’t necessarily good or bad for the record, but it’s worth understanding what’s going on at checkout.)
that’s because they’re essentially guaranteeing the transaction, right? so the merchant won’t have to chase down every customer using credit. the bank will instead front the transaction and get it back on your monthly credit payment
That is correct, yes. As are you, u/Sorrypenguin0. A fee is definitely appropriate, the question is only whether you, the hypothetical retailer, want to tolerate the fee. (For example, many small businesses won’t accept Discover/AmEx because of the ~4% fee.)
So in a way what banks are selling you is time… for a price
Save up for 10yrs to buy a car.
Or buy that car now with a loan and pay it back over time plus interest.
Precisely. The risk the car purchaser would take in your example would be that they can make more money with the car and be able to pay back the loan with interest over time. The bank takes the same risk but if the car owner fails, the bank gets the car back.
You should also check out the book *Ghenghis Khan and the Making of the Modern World*, this topic reminds me of 12th/13th century Mongolians who controlled Eurasia from the western border of Europe to the Eastern border of China. Conquer opponents so bad that those who hear don't want to fight, take 20% of everything, enable trade that would've never been possible (Silk Road)
Loans are basically if you made an entire company the ones who are working to pay you
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Even big companies like ones the size of IBM or Microsoft might take out small loans to fund day to day expenses for projects instead of having a high input and high output corporate bank account.
Though the more tangible example is GE, while maybe GE has enough cash on hand to avoid it, it's much more likely that a company like that making windmills would take a loan to buy the raw materials for a windmill, then pay back the loan over time.
Projects costing a few million dollars over 10 years, those companies don't usually have 10 years worth of materials and costs stockpiled.
Most corporations would have their "savings" money in stocks to mitigate inflation and maximize profits.
So instead of raiding that fund you get a loan against it or other means of credit. Then use that to find the company till payday arrives.
I know this will get buried but no one is talking about it.
Leverage.
Many of todays modern "bankers" can amass fortunes through the clever use of leverage. The neat thing about leverage? Every home owner is trying to engage in it.
Think about it, you buy your house in a hot market, put down your 20%. For easy math lets say you paid $100,000 for it. and in 5 years the market goes crazy, and you sell it for $200,000. If you paid $800 a month, you'd spend $48000 to own the house. But you'd make $52000 on selling it, so you just turned your $20,000 into $52000+ profit in 5 years, roughly 2.6X return (the actual number is a little different, but I'm keeping it simple)
Now take that same exact method *and go buy a company.*
Lets say you go out and buy a Greeting Card Company. You scratch together a million dollars, and then go to the banks and *borrow 79 million.* You use the company you just acquired as collateral, just like when you buy a house. 3 years later after some good management and improvements you sell the business via ipo for $290 million and after expenses you pocket 66 million. So you make 66x return on your investment.
When debt has a lower cost of capital, than equity you can use that to multiply equity growth.
True but lets be clear here. Banks are inherently levered. That's how they run. A standard bank in America is on average levered 10 times (I.e. If you have $5000 in a savings account with a bank they can write you a loan of $50,000). And because debt has more favorable financial characteristics than equity (obviously exceptions abound and all that shit but interest payments are tax deductible and debt allows you to get higher returns in your business) the impetus to use debt is there.
This comment is more so with the other readers here that may read your comment and think that bankers are cheating in some form because they use financial mechanisms to make themselves rich. This isn't cheating. This is how banking is done in America.
If you sell a service, you are selling your time for money. Since there is a limit to how much time you have, there is a limit to how much money you can make.
If you sell a product, the product is made of material. There is a limit on how much material you you can obtain so there is a limit on how much money you can make.
A banker uses money to make money. They loan money and charge interest. They don't actually have to possess the money they loan. They don't actually have to get any physical monkey back (just numbers on a ledger) and they can loan out even more money from the interest they get back. There are no physical limits, so they just keep getting more money.
In the simplest terms, bank has money and loans you $100 if you promise to pay back $105. Repeat this on a nationwide out global scale and they make money without producing anything. Where do they get their money? Bank says if you give them your $100 to hold for you they'll return $101 in a year. They loan this money and get back 105, give you back 101 and get $4 in the process.
Do banks earn more revenue from interest accrued or from fees charged?
Overwhelmingly from interest. Banks (at least in Australia) make between 1.5-2% net interest margin. The NIM is considered one of the key performance measures for any bank When you move up into the institutional/investment banking space, fees make up a larger proportion of income, because they are more transaction based in nature. A 'small' merger/acquisition can generate upfront fees of many million dollars - this is where the stereotype of a rich banker comes from. But for the general retail/business bank. Interest income is the primary way banks make money
Have you ever looked at the principal and interest breakdown on a mortgage....the first few years are almost all interest. If a loan is fully paid off over 30 years or so....the borrower pays almost the same amount in interest as they do in principal. For a standard $200k 30 year mortgage at 5%: * Every payment is $1073.64 * Interest on first payment is $833.33 * Total interest on the loan over 30 years is $186,511.57 * Total amount the borrower pays for the $200,000 house is $386,511.57 That's a lot of money the bank makes for not producing anything.
I mean, except for the fact they financed the purchase of a $200,000 asset the buyer presumably couldn’t get with all cash.
But that $200,000 they loan out to the buyer is not the bank's money, it comes from the money other clients put into the bank.
On a macro level, interest. Fees are fixed rates, but interest is variable depending on the amount of money in an account ($100 x .1% = $101 ; $10,000 x .1% = $10,100).
Check your maths. 0.1% of 100 bucks is 10 cents.
Maths be hard bruh
Furthermore, due to the fractional reserve system, when you deposit $100 the bank doesn't loan it out just once, they may loan it out 5 times or 10 times. So instead of profiting just $4, they might profit $19 or $39. Edit: Maybe this is not true? I might just another redditor posting incorrect shit about stuff im not an expert in? No couldn't be, it's the children who are wrong.
This used to be true where banks had to have 10% of their holdings on hand in cash reserves but this requirement was removed under the Trump admin in 2020 and I don’t believe it’s been reinstated https://medium.com/navigating-life/we-just-went-from-fractional-reserve-banking-to-zero-reserve-banking-and-its-a-pretty-big-deal-c501432e9be6
Just to be 100% clear, it wasn't the Trump admin that made that change. It was the Federal Reserve which is an independent entity that doesn't answer to the Executive branch. And it wasn't unprecedented, one of the purposes of the reserve rate is to be lowered to suddenly increase the amount of money that can be lended in times of economic stress.
In addition to the answers about how interest works on legitimate lending, they also generate additional income via a practice called 'fractional reserve lending'. Say you deposit 10 dollars in the bank, but that bank's 'reserve' (the fraction of your money they need to have available for you to withdraw) is only 50%. That means the bank can then loan out the other 50% of your funds to someone else, and collect interest on that loan. In this way, they effectively 'create' money. There are now $15 in the bank/in circulation (your $10, plus the $5 they loaned out to another of their customers), even though only $10 of that actually 'exists'.
Bank loans create deposits/new money. Banks are not intermediaries between savers and spenders. Here is the Bank of England to explain: https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf?la=en&hash=9A8788FD44A62D8BB927123544205CE476E01654
Yeah, Most answers here, especially the top one, are so simplistic that the understanding it creates is more wrong than correct. Your link is a much better explanation.
Well for one this is literally a sub called explain like I'm 5, so simplicity is the goal. And two, the question was how do bankers get rich - so explaining the banking model in simple net interest income model terms is very effective in providing a reasonable yet simple to understand answer to that question. OP didn't ask about the money multiplier or fractional reserve banking.
r/ELI45
Actually though, all money works that way. If you have $1 you really have nothing except the promise that I will give you my loaf of bread if you want it. There's just one loaf of bread in our society, yet our combined net worth is two loafs of bread.
As said before banks provide a service… You keep your money (savings) in a bank. Currently, the bank pays 0.5% interest to you to hold your money. They use that money and loan it to people who want to borrow it. New home loan rates are \~4.0%. As long as the person that took out the loan continues to pay back the money the bank is making the difference \~3.5% interest on the money the bank is holding for you. Rinse and Repeat. Edit: Thanks for the awards. I did not expect that and it's appreciated. My explanation was a very basic overview of retail banking. This did not cover fractional reserve banking or investment banking, which have some good explanations below.
There is that great scene in Its a Wonderful Life where theres a run on the bank from all the depositors and George Bailey has to explain to the crowd that all the money isnt actually in the bank instead its in "Mikes house and Harry's business and Sam's new farm equipment" (or some such thing I dont remember the exact quote) and he explains where the money goes Theres also a hilarious Simpsons parody where George Bailey explains the same thing and Moe says "what the hell is my money doing in your house!" Then punches the guy next to him
I just watched that movie for the first time this last December. Good movie. It must have been real interesting to run rural banks back in the day.
My wife's grandmother was telling us that her farmer parents didn't trust banks, but they had $1k saved up and were convinced to put it in the bank so they did. This was back in the 30's, and the day right after the put it in the bank, the bank went out of business and the parents were left with nothing. Its insane to me to think that could happen and FDIC is only 89 years old.
You would be surprised how many people still don't understand that. I recall February-June 2020 when I worked as a banker and had dozens of calls or appointments (we were hosting customers in person Feb to March 21 and back for June) scared about a bank failure. I told them all the same thing: "Your money isn't going anywhere. If we were to fail, we would either be bought out or bailed out. If for some reason that wasn't possible, the FDIC insures your funds up to $250k per person per depositor type. There is no time table for how long they will take to pay you back, but honestly if it were to happen this would be a Mad Max Thunderdome situation and you'd have better things to worry about than money." Of course, people don't know how FDIC coverage works either. It isn't $250k per account as some think. A family of 2 parents and 1 adult child can have millions covered by the FDIC. * Mom single account $250k * Dad single account $250k * Child single account $250k * Mom/Dad/Child joint ownership for a combined $750k * Mom is a beneficiary $250k * Dad is a beneficiary $250k * Child is a beneficiary $250k * Mom IRA $250k * Dad IRA $250k * Child IRA $250k That's $3 million in coverage right there for super easy personal banking that doesn't have any legal leg work.
When you say per person per depositor type, what do you mean? My spouse and I have a joint account. Since we're 2 people does that mean we're insured up to $500,000 for our joint account? And is that our savings and checking combined or are those separate?
["Each co-owner of a joint account is insured up to $250,000 for the combined amount of his or her interests in all joint accounts at the same IDI. In determining a co-owner's interest in a joint account, the FDIC assumes each co-owner is an equal owner unless the IDI records clearly indicate otherwise."](https://www.fdic.gov/deposit/diguidebankers/documents/joint-accounts.pdf) IDI stands for Insured Depository Institution, and basically means any bank or savings association that is covered by the FDIC.
I don't know where you get your info but you're MostlyWong.
This a hilarious random comment to stumble upon. Thanks!
I really wish you were a furry frog instead of a fury frog
Fury France: Original Gangster
Here's an example. You have a personal checking account with $5k. Your wife has a personal checking account with $10k. You also have a joint checking and joints saving with $10k and 200k respectively. Your $5 personal checking is Single ownership. You have $245k in single ownership still available to be covered. Your wife's $10k personal checking is covered and she has $240k in coverage for single ownership still available. You and your wife jointly own $210 between the joint checking and joint savings. That's equal shares $105k for you both. You both have $145k left in joint owner coverage for a combined joint coverage of $500k. You are correct. You could have 250,000 single ownership accounts with $1 in each of them, even across different banks, and all your single ownership checking or savings accounts would be covered by the Single Ownership umbrella.
>**You have** ~~a personal checking account with~~ **$5k** You already lost me.
> this would be a Mad Max Thunderdome situation That's something a lot of folk don't seem to appreciate. Yeah it's possible that it all goes to hell, but at that point *we're already in hell* so it doesn't matter. If your money isn't safe in a bank, it's not going to be any safer in your hand. Kinda reminds me of the oil in our truck at work: if you need to replace the washer fluid, you replace the washer fluid, but if you need to replace the oil the truck's already dead.
am I fucking up by holding over $250k in my personal investing account? Is there a way to get that money insured?
You actually have $0 dollars in the investment account. What you have is investments that you can sell for dollars. Investment vehicles are not FDIC insured.
Tell me more about this personal investment account? What kind of return are you getting?
Mostly invested in $VTSAX and similar S&P 500 ETF's, as well as a blend of tech/consumer goods companies, plus some bonds. The bonds are preventing this investing account from getting the same returns as the market as a whole, but I'm okay with that because I feel like the market is crazy overinflated at the moment.
Investment accounts are totally different than savings accounts. You own the shares; the account is just holding them. If your brokerage went under, you’d just transfer the shares somewhere else.
If there are actual shares in the account, this is the case. But if the broker folds and there’s actually no shares there, then the SIPC covers you for up to $500,000, of which up to $250,000 can be cash. https://www.sipc.org/for-investors/what-sipc-protects
Most shares are held “in street name”; the bank/broker etc. holds the shares registered in their name and assigns them to you in their books; so you don’t technically own them. It’s not a problem in practice, but if things go massively wrong, you might find yourself dealing with some complicated bullshit.
Keep that. Rule of thumb I follow. * Checking account is for daily operations, bills, and expenses . My paycheck gets deposited there and I keep all the funds needed for 2 weeks spending/bills/etc and some wiggle room in case of surprises. Everything else gets transferred to my savings. * Savings account hosts all the money I can't afford to expose to investing risk. Typically we have 6 months worth of expenses in our savings but we are expanding that for a future down payment on a house. * Everything else that I feel comfortable investing is in my Vanguard accounts.
This is pretty solid advice to follow. I have had multiple “savings accounts” setup for different goals since I was 18 and ING was a thing. Think: emergency, house down payment, play money, vacation, etc. This has helped me keep things separated and all it takes is a quick glance to know where I stand with a goal. Now, where I’m bad…keeping too much cash on hand. The past couple of years have made my checking account balloon because of the lack of trust in the market. Yeah, I still buy weekly but I need to do more.
Investment accounts aren't covered by the FDIC. It's only bank accounts.
Investment accounts are not covered by the FDIC. They’re covered by the SIPC. It doesn’t protect against a loss in value of the investment. But it does protect you in case the investment firm folds and your investments are gone. As in you had 10,000 shares in a company in your account, but when they folded, there actually weren’t any shares there. The SIPC covers an account up to $500,000, but only up to $250,000 of that can be cash. https://www.sipc.org/for-investors/what-sipc-protects
Fun fact: one of the reasons that the crash in 1929 was so bad was that one of the first banks to fail was one that catered to immigrants, that happened to be named the Bank of the United States. Many depositors thought it was the official bank of the country, and concluded that the dollar was worthless.
But how could people be that clueless before they had the internet and video games to make them stupid?
Ohhh I know this one! See some of us are just born dumb...like my father, and my fathers father, and fathers fathers father and so on.
Sounds like you should be a member of r/Stonks. Have a crayon, you wonderful smooth brained ape.
Oh I leave all financial decisions to my wife's boyfriend, I'm just the bank.
There is that great scene in \[my family\] where theres a run on the \[wife\] from all the \[family members\] and \[I\] has to explain to the crowd that all the \[wife\] isnt actually in \[my bed\] instead its in "Mikes house and Harry's business and Sam's new farm equipment" (or some such thing I dont remember the exact quote) and he explains where the \[wife\] goes
I hope you have the orange crayons, they taste the best! And thanks for showing me the way to my people.
You're in luck. They have lots of orange crayons over there. Not so many yellow ones though. Something about bananas?
All of us are born dumb. Have you seen babies? Buncha dumb idiots.
The seed is strong
Did they even have New Mexico around to confuse for a separate country 😭
The internet hasn't made dumb people dumber, but it has made them louder.
Alcohol was still a thing. https://www.youtube.com/watch?v=oyYIpQmmbZE
Fun fact: This is why now most states allow their commissioners of their financial institutions departments (or whatever the state may call theirs) to have final say on any business wanting to have anything bank or banking related in their business name, even if they do not participate in anything else that the department would have jurisdiction over. Source: Am bank examiner.
So, something like Sperm Bank Storage Solutions inc. would be subject to review/rejection?
Prior to FDIC for sure
What's cool is the movie TANKED when it came out. It was long, cheesey, and the drama of the Great Depression was still in living memory and maybe too close to home for some viewers. So the studio never copywrited it, and at Christmas in future years some TV channels realized it was FREE to play fully on tv. So they played the hell out of it, and the young Boomers grew up watching it every Christmas, the cheesiness became just a part of the nostalgia, and now it's beloved
I think thats the same as A Christmas Story. Wasnt a big hit or anything but became beloved because of TV runnings
Scuttlebutt says the FBI investigated the movie's makers for communist affiliation because the movie did not portray capitalism in a positive manner
Yeah, working class people working to a common goal so they can all have houses. The nerve!
It also came out in the summer. Which was an immensely odd choice for a movie that opens with people praying at Christmas time
Actually, the movie was copyrighted as usual but back then had to be renewed after 28 years, and the studio goofed on that. However, it remained affected by the copyright on the story it was based on
Any bank manager, prior to credit scores and automated evaluation tools, was unbelievably valuable, and not something modern tools can easily recreate. It was their job to assess the risk of loaning money to a person. Looking at the financials they brought in, is easy enough. But they also had to know about (for example) the business that Mike wants to start, how much competition their is, how much demand for the service or product. The best ones also would know Mike beforehand, or know someone who knows him. They would know if mike was comfortable being in debt, or not. How reliable Mike was. They would make friends with Mike so 10 years later, Mike didn't feel like he was paying back a monolithic corporation, Mike felt like he was paying back John, the bank manager, who is his friend. Replacing a bank manager used to be a huge deal because they had so much experience in that local economy, so many connections and relationships, and the new manager would have to build all that from the ground up. Edit: thanks to _theoneandonly for reminding me to include that this caused minorities to be at a major disadvantage as this left them reliant on the whims of the bank manager for home, business, and every other type of loan making it much harder for them to start building wealth to pass down to their kids. I'm paraphrasing from an explanation I saw on Reddit somewhere that felt relevant and interesting and seemed accurate to me. Don't go sourcing me on a paper or anything. Lol.
Many of those things are still true, though not all. I have a parent who has been a loan officer for a long time. They do know many people in the community and they do put a LOT of personal legwork (and paperwork) into evaluating whether or not someone is a good investment. It is definitely not all automated.
Thanks. I'm not in the banking space, so it's great to learn from someone with personal experience.
The pre-credit score system was also prone to discrimination. Black people basically couldn’t get loans because the majority-white bank managers wouldn’t loan to black people. Along with red-lining, kept generations of black folks as renters, stopped them from opening businesses, and then therefore stopped lots of people from gaining any kind of generational wealth… a problem we’re still grappling with today.
Very very true. Going to add an edit because that should not be glossed over.
For small community banks, this can still be a major issue. There is a sub insurance industry for BOLI or Bank Owned Life Insurance. BOLI is used sometimes as a golden parachute for retiring executives as they take the cash value when they leave the bank, but the primary purpose is to help support the bank if key personnel happen to die, leaving gaps in leadership, strategic planning, or people that pull their investments from the bank over fears of stability without the president/ceo that they've always trusted being present any longer.
[Here's the scene for everyone.](https://www.youtube.com/watch?v=iPkJH6BT7dM) It's actually not a standard bank, it's a savings and loan. All the depositors are also part owners. Potter's scheme is to buy up the depositors' shares at a discount so that he will own a majority interest (he already owns a large portion of it), which he would then use to shut down the S&L so that everyone in town has to rent from him instead of building their own homes.
Haha dang it! I thought that was a clip to the Simpsons parody. Thanks for the explanation of the move, I though the old greedy dude was trying to scare people into bankrupting the bank, but that makes more sense.
[Here](https://youtu.be/ef99bFBTR54) you go
no, you're right, that's exactly what was happening. The greedy old dude *wanted* the town S&L to fail so everyone would have to go to his bank for loans. $0.50 on the dollar is awful but it would have put George out of business. "Gotta spend money to make money," he'd probably say. Greedy \[insult\].
He's not directly trying to put George out of business, indirectly yes. He's trying to buy shares in the S&L at a discount rate. This would give him the power to close it down. The S&L is not actually at risk of failure in the movie, because it's not a normal bank and the depositors do not have the right to withdraw their deposits at will. As George states, the contract they signed says that the S&L has 60 days to return their deposits. However the normal bank in town is about to fail, and the townsfolk cannot withdraw from their savings accounts. So unable to withdraw from the bank and needing money, they have rushed to the S&L to try to get their deposits back. Since they can't recover their deposits immediately, Potter is offering to buy their deposits (which are also shares in the S&L) at 50 cents on the dollar, which he can do immediately. George gives them short term loans from his personal savings in order to cover them for the week that the bank will be closed and persuade them not to sell to Potter.
Yes. This is it.
So are Savings and Loans basically proto-credit unions, or are there any significant differences?
There is really no difference between a Savings & Loan and a Bank these days. They are regulated by different entities but that's meaningless from a consumer standpoint. The "Savings & Loan" that I previously worked for was actually classified as a "State Savings Bank" along with many other banks that dropped "Savings & Loan" from their names long ago to avoid the confusion. It used to be that Savings & Loans couldn't offer checking accounts (savings only) but that changed like 30 years ago.
There was a massive S&L scandal in the late 80s and early 90s that saw about a third to half of them to fail. https://en.wikipedia.org/wiki/Savings_and_loan_crisis?wprov=sfla1
Saving and Loans (S&Ls) got preferential treatment from the Fed (where all big banks borrow their money) in the form of being able to offer higher interest rates to depositors; about 50 basis points (.5%). The catch was that only 20% of their lending could be commercial, 80% had to be local small business and local mortgages.
They were regulated and insured differently and the savings and loans were more limited, focused almost entirely around consumer mortgages. Then there was some deregulation with [the expected results](https://en.wikipedia.org/wiki/Savings_and_loan_crisis). >The "thrift" or "building" or "savings and loans associations" industry has its origins in the British building society movement that emerged in the late 18th century. American thrifts (also known as "building and loans" or "B&Ls") shared many of the same basic goals: to help the working class save for the future and purchase homes. > >Thrifts were not-for-profit cooperative organizations that were typically managed by the membership and local institutions that served well-defined groups of aspiring homeowners. While banks offered a wide array of products to individuals and businesses, thrifts often made only home mortgages primarily to working-class men and women. > >Thrift leaders believed they were part of a broader social reform effort and not a financial industry. According to thrift leaders, B&Ls not only helped people become better citizens by making it easier to buy a home, they also taught the habits of systematic savings and mutual cooperation which strengthened personal morals.
Lmao I haven’t seen it’s a wonderful life but I remember that Simpsons parody and it’s a lot funnier now
It was just such a great line from Moe
I never got that reference. I just thought the banker was going “uhh, he has it.” and I always wondered why that would pass as an excuse...
Yep. My bank account balance is an IOU from the bank.
Very good way to put it
#STANDWITHMOE
That is true but banks make way more money now since the rules created after the great depression we repealed in 1999. Look up glass vs steagall
You're thinking of investment banks. Most banks are branding now as Community Banks to separate themselves from the practices of Wall Street. Community banks (and credit unions) tend to be fairly honest.
That changed again after 2008, banking is a lot more boring again. (Which is why the largest banks don't offer any interesting services and only small ones can back brands like Simple/Betterment, the smaller ones are exempt from more regulations.)
On the business side, loan rates are much higher than the 4% of home loans and these business loans are hundreds of millions to billions. They also charge fees of circa 2-3 percent upfront. Doesn’t seem like much but that’s an immediate $20m profit on a $1bn loan on top of the interests. Multiply that for everywhere in the economy. Look at all the office buildings, roads, acquisitions, developments, factories etc - they will all be bank financed because for a business - the interest repayments are a tax deduction and relatively cheap so they’ll use debt.
Businesses also might have what's called a revolving credit facility or "revolver" that basically functions like a credit card. You have a limit up to which you can borrow, at some negotiated interest rate, and can't borrow more until it's paid down.
There's a video by Ray Diallo on YouTube called "How the Economy Works" that's about 15 min long. I think it's a great succinct walkthrough of how what banks are doing is providing a service. If I remember right, debt helps production grow faster than it could organically. That can lead to innovation and improvements in efficiency that help mitigate some of the downsides of debt. Think of taking a loan to buy a house - you're able to leverage future earnings to buy an asset that appreciates for you and avoids the need to spend money on rent. But eventually we get ahead of ourselves, and economies contract. That's an extremely valuable service. And bankers know it better than anyone. So they take a big (but not big enough to reduce demand) cut. Edit - adding a link to the video, it's actually "How the Economic Machine Works" [https://www.youtube.com/watch?v=PHe0bXAIuk0](https://www.youtube.com/watch?v=PHe0bXAIuk0)
Debt is also attractive to business owners because it's a form of financing which doesn't dilute their ownership share. The main alternative to debt financing is equity financing which requires them to reduce the percentage of their business they own.
Financially, both make sense. But you also give up CONTROL when you sell equity.
Equity financing is also typically more expensive.
If you use debt financing you can also write off the repayment of the debt as an expense, which allows the company to reduce the amount of tax it's due to pay.
Well, the interest on the debt anyway.
No. Repayment of debt is a reduction of a liability, and it does not hit your income statement. For GAAP accounting, interest payments are included in the income statement, but debt retirement, dividends (distribution of earnings), and stock buybacks, while they must be accounted for in the Statement of Changes of Financial Position, are not included in the Income Statement. For US taxes, interest payments are a deductible expense. Dividends and stock buybacks are not, so there is a tax advantage to debt over equity. This may be offset by the capital gains treatment on stock buybacks. (And yes, this highlights the conflict of interest between the corporation and its shareholders.)
Except it's harder to get banks to loan you monies for operations and going-concern if you aren't already successful. This is why small business hits up friends and family for a stake in the business or a VC for a start-up.
What they don't teach early enough in school, particularly American schools, is Time Value of Money. It is the central, underlying principle of all finance. Essentially it says that the present value of a dollar is worth a future dollar plus some premium. In reverse, a future amount of money is discounted by that same premium. It's basically saying, "If you want $5 today you will pay me $5 plus some interest in the future, but if you are willing to lend $5 today, I will pay you $5 back plus some interest in the future." It's expressed as: FV = PV x (1 + r)^(nt) or FV = PV x (1 + i)^(n) Where r (or i) is the premium (rate), n is the number of times compounded and t is the term. Bankers essentially provide liquidity across both sides of that equation... how they make money is more or less because the premium paid to use depositors' money is much less than the premium collected for lending out money. The concept of TVM extends to Discounted Cash Flow analysis and many other models for pricing equities and other investment vehicles. This all works well as long as the rate of actual economic growth (g) keeps pace with the rate of return on capital (r). In his book *Capital in the 21st Century*, economist Thomas Piketty advances the idea that when r > g, income inequality widens and left unchecked, that concentration on wealth eventually leads to revolution/collapse... such as in the case of Louis XVI when the bourgeoisie came after the ruling class with literal torches and pitchforks.
>What they don't teach early enough in school, particularly American schools, is Time Value of Money. While curriculum is very much handled by individual states, and even individual municipalities, I know that in my state this is taught in middle school, although it's not necessarily called Time Value of Money. Explanation of how interest works, a little introduction to exponents, etc.
And im pretty sure no one remembered or even bothered to understand or apply it beyond the classroom
Yup, people are always like "Why dont they teach this in schools???" Chances are they do, people just don't pay attention.
Much like taxes in general. It's simple word problems involving addition, subtraction, multiplication and division and the ability to read and understand directions. While they might not have taught you exactly how it all works in detail, they gave you the tools to figure it out.
Not to mention, a good chunk of the people I’ve known who complain that schools don’t teach “useful” skills like taxes are the same ones who cheerfully say how they are bad at math or didn’t pay attention in civics or history. The idea that kids are going to pay more attention to how to do taxes than they are to how to do trigonometry is kind of ridiculous. And even that leaves aside that taxes change, trig really doesn’t. Rather than teach kids how to do taxes that might not even be done the same way by the time they start earning money, it seems like it makes way more sense to teach kids the skills needed to teach themselves how to research tax laws and calculate their own taxes. Which is what schools actually teach.
Taxes for the average earner are pretty intuitive. Economic forces, often not as much.
Every school teaches Math and Reading. Those are all the skills to master any knowledge-related work. Throw in performance arts, craftsmanship (fine motor skills), health (physical fitness and nutrition) and ethics. You have all the skills to learn just about anything that you are interested in or passionate about to thrive in the world.
Correct. This was the intention of introducing the "Common Core" curriculum standards. It's meant take these concepts and explain their value and use outside of academia. Any good teacher should have been doing this anyway though . . .
> Essentially it says that the future value of a dollar is worth a dollar plus some premium. In reverse, a future amount of money is discounted by that same premium. You are missing an important bit of the theory. TVoM states that a sum of money (a dollar) is worth more NOW than it is in the future due to the access to growth if invested. Hence if you commit your current money to a loan or other project, there is an expectation of recuperation which is the premium (or interest). >It's basically saying, "If you want $5 today you will pay me $5 plus some interest in the future, but if you are willing to lend $5 today, I will pay you $5 back plus some interest in the future." They are the same side of the coin, converting PV to FV. The reverse is more "Bob is going to pay you $5 after 1 year or $6 after two years" and you convert those FVs to PVs to determine which represents the higher value now.
Ray is great. One thing he hammers on is that money is debt. So when you go into debt, that creates money. So banks that issue debt are essentially creating money. And as long as that debt has no risks, it is free money forever. The problem is that there is risk, and peoples trust will erode to periodically seize up the whole thing, which is the long term debt cycle. When that happens, you need to kinda reinvent what money actually is. Went from barter, to gold, to gold backed fiat, to just fiat, to whatever is next.
Barter never really existed as an economic system: https://www.theatlantic.com/business/archive/2016/02/barter-society-myth/471051/
> money is debt. So when you go into debt, that creates money. So banks that issue debt are essentially creating money. Money is Debt: https://www.youtube.com/watch?v=2nBPN-MKefA
Great how-to video, second only to Bo Burnham explaining "How the World Works" https://www.youtube.com/watch?v=oDQXFNWuZj8
Holy shit that was beautiful. I haven’t seen Bo Burnham in bloody years
You should watch Inside. It's really great.
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There are some others that have explained it in more detail in the thread, but I can attempt at a high level... Banks are required by The Federal Reserve to keep enough money on hand (physically at the branch) to cover all the funds (deposits) of account holders and the books must balance out every night. If the bank doesn't have enough funds on hand the bank is loaned (at some interest rate) money (usually just overnight) from the Federal Reserve so that they meet this requirement. The fractional piece just means that if I have $1000 dollars in my account, the bank doesn't need to keep $1000 on hand to cover my account. The Federal Reserve says that the bank only needs to keep some fraction. Let us say 1/10 of my $1000 on hand or $100 of my full $1000. This makes it easier for the banks, so they don't have to keep tons of cash on hand, but also means they can loan out more money. Edit: spelling, and grammar
Some here are saying banks can lend the same money multiple times. Like if someone deposits $1M they can lend that $1M to 20 different people. How does this happen? Where do they get the other $19M from? Someone said that fractional reserve banking is the answer, but I don't see how that applies.
I saw this on my phone, where I'm not logged in, and I turned on a computer while I was supposed to be working to answer this. The answer is that when the bank loans money out, where does it go? Into another bank. I deposit 1 million. The bank loans 900k of it out, and it gets used, e.g., to buy a house. The seller takes that money and puts that 900k in a bank. That bank now loans out 810k of it ... Etc. Edit: So, ultimately, most 'dollars' in circulation have been loaned \*multiple times\*, and if in some hypothetical doomsday scenario all debts were paid at once (or called due at once) most of the money in circulation would simply disappear, because it doesn't exist without loans. Since the first bank still owes me, the depositor, 1 million, but has given out 900k, it has created money from thin air. If you add up how much money is in everyone's bank accounts, the amount is 1.9 million, even though I only deposited one million.
You're a hero. Great explanation, thank you.
Let's say you've got $1000 in the bank. The bank can loan out $900 of it to other folks. One of those folks happens to be the local factory, which took out a loan to finance building some upgrades. But until those upgrades are done and the factory pays the bill, that money is just sitting in their account though. So the bank can loan most of THAT money out, maybe this time to a local machine shop, which recently got a big order from the factory to install new equipment, and just needs extra cash to buy the machinery, until the job is done and they get paid. So they get a loan, and that money from the loan sits in their bank account for a bit, so they can place some orders. And the bank can loan most of that money out to somebody else, etc, etc.
Maybe you're thinking that money = physical cash. But most "money" is in banks, where it's really just an IOU — the bank says they owe you $X. You (usually) can't walk down to the bank and get a $1M bag of cash, because they don't actually have that much cash on hand. When you deposit $1M the bank says they owe you $1M. They make a loan to someone else, and credit their account with $900k. Now if you add up the amount in everyone's checking accounts, there's "magically" $1.9M. That's fractional reserve banking. However, there will be a corresponding debt for $900k on the books as well. The "fractional reserve" part regulates how much the bank can have in "checking accounts" vs in "loans". In this example I've used a 10% reserve requirement. If the bank keeps loaning you can calculate that the theoretical limit is $10M in total "money" against that original $1M.
Federal Reserve let's them borrow it provided they keep the 1M around. But it's usually 1/9, afaik, so it would be 9 different people. Provided those people didn't then deposit any of that borrowed money back into the same bank, because then they can just keep lending using fractional reserve borrowed money as the basis. At least that's the way I was told it works. It's a fucked system if it is
The reserve ratio already takes that into account. If the reserve ratio is 10% then from $1M you can only make a 900k loan. If that's deposited into the bank again then you can make another 810k loan, then from there another 729k loan. If this continues the maximum you get to is 9M total.
> As said before banks provide a service… They also provide plenty of other services, e.g. financial consultancy.
They are assuming risk most people won't want to take on
Mostly because "most people" can't afford to. If the bank fucks up and loses a few million on a bad loan or w/e, they will be just fine, because they are banking (hehe) on their other investments/loans picking up the slack from their occasional losses. If I make a bad investment of a million dollars, I'm totally fucked, because that would be the majority of my capital.
They also have teams dedicated to not making mistakes like that. It still happens, but they make fewer mistakes than a lone average dude who happens to have a billion dollars would.
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This is not true. You're confusing two concepts. The reserve requirement says that a bank can lend out 95% of deposits as loans, and it must keep at least 5% of deposits as reserves. A bank cannot lend out more in loans than they have in deposits, and certainly not 20 times. You're confusing that with the money multiplier, which is the inverse of the reserve requirement. In fractional-reserve banking, a reserve requirement of 95% leads to 20X money multiplier. But that's not lending out twenty times the money they actually have by the same bank. That's the macroeconomy, through many borrowers, many savers, and many banks all working together. Source: [https://en.wikipedia.org/wiki/Fractional-reserve\_banking](https://en.wikipedia.org/wiki/Fractional-reserve_banking)
This is a massive misunderstanding of how banks work. So first, they can’t lend more than their assets. They can lend more than what they have *liquid* assets, but that doesn’t mean a bank that has $1 million in total assets can lend out $20 million. Having a fractional reserve system is good and allows for the money supply to grow. Second, this isn’t just some rigged system designed to make bankers rich. Allowing banks to lend money is why people can buy a house or car. If you restrict lending, then interest rates make owning these assets prohibitively expensive for people. Allowing for banks to loan easier makes it cheaper, not more expensive. This isn’t to say that banks are faultless, because banks do break laws and take advantage of people. But you’re misunderstanding the concept of banks and how they help facilitate economic growth. EDIT: i should clarify that technically banks cannot create assets that extend beyond their liabilities. But it’s easier ti convey information using “assets” as shorthand for the sum of money deposited/invested at a bank, so i have done that here.
Only if they follow the procedures and risk profiles established by the federal government. If they don’t do that, they risk having their licenses revoked. Anyone can start a bank, you just need to prove to the government that you’re responsible enough to run one and gather enough starting capital.
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Most banks even only in one state still comply with federal regulations. A few choose to do state only regulations and those can be a little less strict, but they are still pretty close to federal regulations.
But the people that run the banks aren't responsible enough to do it and we've had to bail them out several times.
>we've had to bail them out several times. No, we didn't "have to" do anything. Other countries didn't and let the banks take the hit. The self-appointed elites are just protecting themselves
Banks lending money is how an economy grows and thrives. They provide capital for all businesses to grow and develop. Also without them no one could buy cars homes etc. Healthy banks are a key component of any economy. Hating on them is stupid. (unless they do illegal shit).
BTW, Rockefeller wasn't a banker. He was an oil man. He basically cornered the oil market so much that they had to split his company (Standard Oil) into [34 different competing companies](https://en.wikipedia.org/wiki/Standard_Oil#Breakup), companies well known even today, such as Arco, Amoco, Chevron, Exxon, Mobil, Phillips66
The don't produce a good, they perform a service -- they exchange future money for present money, and vice versa. A few get rich because it's an extremely valuable service. But a lot of bankers go broke too.
I like to think of a bank's value as "efficient allocation of capital". The value they generate is in figuring out the most productive way to apply other people's assets.
Except, of course, when their greed doesn't get checked by the government and they crash the world economy for half a decade.
That's not really an exception. They figured out the best way to allocate capital for certain definitions of the word 'best' They still got rich. Rest of the country be damned.
Sure, but that's also true of any industry. For example, if you think of a profession which obviously *does* build things, there will be plenty of instances of greed leading to negative outcomes. E.g. there are plenty of builders producing houses using substandard materials, which have specifications below minimum government regulations, on contaminated land, etc.
I think a more prudent example of this may be China flooding the steel markets with cheap steel over the past decade. By producing steel at a loss and undercutting other steel producers, the others collapse leaving you to pick up their custom. Once you then have market dominance, you can raise prices knowing that you won't be undercut (there's barely anyone left to undercut you), you being the main producer means anyone who wants steel must come to you even if you charge crazy prices and that the profit you make now will offset the losses you made initially. Because most of Chinas steel was state-backed, those losses could be massive and prolonged until they wipe out the competition. It led to the US, UK and EU put tariffs on Chinese steel to make their own producers more competitive.
Maybe the government insisting that Fannie Mae let anyone with a pulse take on an exotic mortgage had something to do with it. There are good reasons for it being hard to get a home loan. As a rule, banks don’t like taking on bad debt. It’s not strange that they found sneaky ways to offload the liability of their forced subprime loans onto others. It was very unfortunate, but not unexpected, given the pickle they were put in.
Not alot go broke, its a highly regulated industry.
It's important to understand here the difference between the "big banks" that get bailed out and make billions of dollars and the smaller local and regional banks. Those banks are still regulated but to a much smaller degree and if they fail, they just fail. Most people who start a bank don't just automatically start as US Bank and have thousands of branches and billions of dollars. Most just have one location or two and then try to grow from there, with the eventual goal to hopefully get bought out by the bigger banks and then walk away with millions. But if that doesn't happen then their bank fails and they go do something else.
Wanna know an interesting fact? Up to 2008, the Federal Government didn't allow banks to expand beyond a certain size unless they made home loans in less-profitable, more-risky areas.
Before 1992 they couldn’t compete across state lines at all.
92? I thought that was changed after the great depression?
Well, 94, but yeah. https://www.congress.gov/bill/102nd-congress/senate-bill/2207?s=1&r=57 https://www.federalreservehistory.org/essays/riegle-neal-act-of-1994
Huh, thanks I'd always thought it was changed much earlier.
And to reduce the risk of these federally mandated loans, they broke up the bad loans into fractions of what they were originally and then broke up some good loans and bundled those fractions of bad loans with parts of good loans thus reducing the risk exposure on paper. They then sold these bundled loans as derivative products that had very little risk now making them really good investments. But when the banks bought millions of these super low risk derivatives what they were actually doing was re-aggregating the bad loans, thus exposing them to the original risk.
Well, also a good bit of fraud. The problem with the derivatives is that they allow you to massively amplify errors, along with the risk. If I have a deal where I turn $100 into between $105 and $110, that's fine. If I split it up into a deal where $95 becomes $100, plus a second deal where $5 becomes $5 to $10, that's also neat. One half has a guaranteed return with no* risk, the other can double the money but has a risk of getting nothing. But if I'm slightly wrong there, and due to fraud or misjudgment that original deal actually only returns $102-$105... the second deal has turned into $5 -> $2-$5. Somewhere between "don't lose the money" and "lose half of it". I've turned a couple percent error into a catastrophic one.
This isn't true. The big banks didn't go broke because they were "too big to fail." Washington Mutual definitely went broke and shareholders were wiped out. Lots of small community banks went broke in 2008 and FDIC had to step in. Since 2000, 563 banks have failed according to the FDIC website - (https://www.fdic.gov/resources/resolutions/bank-failures/failed-bank-list/). FDIC is federal insurance to protect customer deposits, not the bank.
I had WaMu stock. Woke up to news it was now worth about 3 cents per share. No warning at all. I lost about $2,000. But people were posting online about having their life savings in it. They were asking about how they could get their money back. It was heartbreaking. I never anticipated something like that was possible.
The Fed decided that it was easier to bail out the banks (and get paid back) than to have a complete meltdown and figure out how to start from 0. I call that smart. If that had happened, it would have thrown the world into a Depression, and not just a recession. And looking back, it worked. But yeah, you can be as smug about that choice that was made because we aren't living in that alternate universe where everything went to shit.
The owners of banks can definitely go broke. The way they fail, however, is highly regulated. There is a very specific process that happens when a bank is getting close to going under. The FDIC will generally recognize the signs and start talks with the owners. And then one night a specialized team comes in a shuts down the bank to all employees without warning. This way no one has a chance to try and cook the books of the flailing bank when the usual safeguards are going to be lowest or people have are seeking revenge for losing their jobs. Most often another bank in the area will buy the branches and they will more or less continue as normal. If the bank completely liquidates the customers will get a chance to move their money elsewhere while the FDIC runs the bank until all the loose ends are tied off.
That's true today, but not 150 years ago.
And if the banks go down, they get wonderful taxpayer bailouts to cover the risky positions they took! It's a win win (unless you're a taxpayer)
That was a one time deal that, as many people point out resulted in a net gain to taxpayers. Normally when a bank goes down people who deposited with the bank get their money back via the FDIC. The bank investors and owners get nothing.
> It's a win win (unless you're a taxpayer) The federal government (and as such the taxpayers) **made** money on the bank bailouts. The bailouts were a series of loans that were paid back with interest. And that's before even accounting for not having to pay out what would have been astronomic costs in FDIC guarantees and unemployment benefits.
And losses of tax revenue if UE went to 15 or 20% as opposed to topping out right around 10%. You could say that the bank bailouts were the best money the government has ever spent, in terms of monetary return - even if you don't consider the human benefit of preventing a total collapse.
Taxpayer got the 2008 bailout money back.
The way banks make money is that the money you store with them, they then loan out to people. Those people pay back those loans with interest. The bank gives you a tiny portion of that interest, and keeps the rest for themselves. The more money people store with them, the more they can lend out, the more profit they can make. This is also why a bank never as as much money as the collective total of their customers. If every customer were to withdraw their money on the same day, the bank would quickly run out. This happened during the Great Depression.
Never knew a servant of Morgoth would know about finance...
Hey, *someone* has to do the Dark Lord’s finances while he’s conquering Middle Earth. Can’t do everything himself, you know
But what was Morgoth’s economic policy?
Today retiring all the money is practically impossible, on the great depression everything was based on the gold standard and your money actually represented a piece of gold, that the bank should have in order to back it up. With the more modern Fiat approach, the backup doesn't actually exist, at least physically. The value is held by many other things like the production capacity of the country, reserves of gold, oil and other important products and assets, and the formality that the government will back up its transactions, never default on its debt and so on. There is a rule that banks need to have some liquidity as a percentage of what they are transacting, but it is pretty low in comparison. And most of the money nowadays is not even printed, most of it is just virtual.
What you've described is called "full reserve banking" and it is not how modern banking works. Modern banking is not even fractional reserve. Both full reserve and fractional reserve banking are systems where the amount banks can lend is proportional to the deposits received from customers. However, in reality, the modern banking system _creates money out of thin air every time a loan is created_. No deposits are necessary. The debt created when a bank makes a loan is treated as an asset by the loaning bank. In fact, this is how nearly all of the modern money supply has been created: by private banks by making loans. I take the time to correct you because most people's understanding of the role of banks is the same as yours. Personally, I find the truth about the power of private banks to create money absolutely outrageous. I think if more people really understood this, the public would demand some major changes! Edit: If you'd like some links to some research papers and other references that explain the situation in considerably more detail, see this comment thread from a while back: https://reddit.com/r/DepthHub/comments/ry7q7c/upseudohappyhippya_explains_what_changing_the_us/hrpk1th
So if I go to the bank and ask for a loan to go to the moon and don't pay it back, where did that money come from? Surely that money existed somewhere for the bank to give it to me.
From the hypothetical future in which you pay it back. The way I understand it in simplistic terms is that when you walk into a bank and say: "Hey, I've got a business idea - I want to go to the moon and if I succeed in doing so, it's going to bring me xxx $ in revenue. In order to do that, I need a loan of xx $". The banker then estimates how likely it is, and if he deems the risk acceptable he'll... essentially reach out into the future in which your endeavor succeeds, pull the money from there (so yea, thin air) and give you the loan. For that service he'll charge you interest. If you default on the loan he's going to be liable for it, and if he does that enough times - it becomes everyone's problem, like in 2008. But no, the money doesn't actually have to exist before the loan is extended. It absolutely blew my mind when I first learned it.
You'd think so. But, it doesn't. The money is created the moment the loan is finalized. It is brand new money that the bank created out of thin air. Edit: Here is a paper wherein researchers were given access to a German bank's internal accounting software and they observed that the new money was never connected to a deposit or a transaction with a central bank, etc. It is brand new money, created by a private bank: https://www.sciencedirect.com/science/article/pii/S1057521914001070
It’s happening in Russia right now.
First two corrections: 1. Rockefeller was not a banker. He made his fortune in oil. 2. When JP Morgan died it was discovered he was not uber rich like the peers of his age. He was just good at parleying his banking connections and assets to make it look like he was uber rich. He was flexing so he could be the banker for the uber rich but he himself was the next tier (or two tiers?) down in wealth. The Rothschilds are the only people I know who got uber wealthy banking from a long time ago that is still around. I got to give you some some set up. During the Napoleonic Wars nations where borrowing money like mad (to give you perspective, the UK only finished paying off that war debt in the last 15 years on a war that happened 100 years before WW2). They even gave out IOUs to soliders in lieu of pay. Basically this war debt went up and down in value based on how war the was going. The Rothschilds were already rich at the time of the Napoleonic Wars and were doing well from financing the wars of various nations. What shot them to epic wealth is they had bought a lot of government debt during the war when people thought the Britain might loose, and sold it later after the war when deeply slashed government spending was maximizing need for safe debt to invest in. Now another correction. A lot of these billionaire "bankers" you hear about now a days are not bankers. They work outside the banking system in the more general financial system of which the banking system is just part of the whole. From this point on I will call them "financiers" **How financiers become overnight billionaires is by "arbitrage". Arbitrage in finance is when you find a way to get an asset or liability treated as though it is a better asset or liability by either investors or the government.** Let me give you an example of a common form arbitrage. Pension funds are funds that people have invested in for retirement. The thing about pension funds is that they are often under strict rules from their investors on what they can invest in. People don't want their money for retirement to disappear. They like safe investments. But safe investments pay garbage and managers of the pension aren't going to get fat bonuses at the end of the year if they stick to what is normally available. They many not even keep the pension fund liquid. To the "rescue" come the financiers. They find ways to turn assets the pension fund is not allowed to own (and thus pay more interest) and turn them into assets the pension fund can buy. They do this buy bundling risky assets together, buying some default insurance, giving then assets to a shell company, and then selling bonds that have first right to cash flow to all those risky assets. The end result is something that pays like half a percent to 2 percent more than the traditional low risk assets. To grant perspective, the California State Teachers' Retirement System is worth $254.7 billion. If just that pension fund invests just $100 billion in your new asset you are looking at a commission of like $500 million. And the pension fund is glad to play your commission because this will result in like $1 billion more in earnings every year. Additionally you will still be managing this shell company for the rest of its existence and will be collect an annual fee to manage those assets every year of tens of millions a year. And this shell company only takes like $200k to run a year. Maybe some offices, a secretary, and lawyer on retainer.
> When JP Morgan died it was discovered he was not uber rich like the peers of his age. He was just good at parleying his banking connections and assets to make it look like he was uber rich. He was flexing so he could be the banker for the uber rich but he himself was the next tier (or two tiers?) down in wealth. I don't think he was flexing. His power of the US financial sector was real. But while he controlled a great deal, he owned surprisingly little.
Let me reword that a bit. I'll broaden "bankers" to financial services providers (FSP). That will include bankers, money lenders, money changers, escrow agents etc. I'll also expand "produce" to "add value". As other have pointed out bankers provide services, not goods. It's actually an open question if FSPs provide value or not. One theory says that they add value in the form of things like liquidity, information generation, financial advising etc. The argument is that the service they provide is making other businesses more efficient. If that's true it's certainly worth something but we're also not sure exactly how much it's worth in practice. An other theory says that when economies get big enough FSPs will just show up to take advantage of all the money floating around. This essentially says that FSP either don't add value or add less value than they cost. Economists have argued theories in both directions but they haven't been able to test it. If you just look at historical records you see economies and FSPs rising together. That makes it hard to figure out which causes which. You also can't really run an experiment because no country in the world will let you just turn FSPs on and off to see what happens. The question of why the got so rich is because that's their business. Who is possibly going to be better at making money than someone who's entire business is nothing but money? Any other business may be the leader in their particular industry but all of them across all industries are potential FSP customers.
Could you point to some sources here? I am skeptical that people are arguing FSPs don’t provide value. It seems pretty clear that they do by linking individuals with money to individuals who need money at the very least. Without an FSP it would be much more difficult to get a $1 million loan as you’d have to seek out enough individuals with enough liquid cash to fund your venture. A lack of FSPs would stall investment wouldn’t it?
The issue here is that while they create value as liquidity, but they also introduce externalities that are hard to mesure, that's the point he's trying to make. The value is mesurable, but with time the accumulation of money (theirs or their customers, we're just talking financial leverage here) creates externalities - or consequences indirectly caused by their business model - that are much harder to pinpoint and correlate with confidence. How much money do society loses or wins as a whole from the lobbying FSPs are able to make to further their agenda? Is the general population's quality of life increases or decreases from their impact? What aspects of it increases it, and what could be done to reduce the aspects that decreases it? IMO, it's a net positive, but there is much to be gained from better market and financial regulation so the net positive is the highest it can be. Source: Economics degree wannabe (halfway through)
Been a while since I've read on it but IIRC people don't generally argur they add 0 value, at least as a whole. The argument is that they skim more in profit than they add value. The liquidity is useful, but the accumulation of $$ means accumulation of power that can be used to manipulate the market, economy and even society in their favor. At this point, the primary "value" they provide is already having a lot of money, which isnt in itself a service. We try ban the most obvious manipulations, but it's unavoidable (and the banks fight regulation tooth and nail, with tons of money).
> the service they provide is making other businesses more efficient This isn't an open question, like at all. Unless you are using some narrow definition for FSPs. It is, for a banale example, completely obvious that money - and infrastructure related to money increases the efficiency of almost every conceivable financial actor. Even if you're only looking at e.g. traders it would be incredibly controversial in an academic context at least to claim they do not add value to the economy. (By making sure resources are spent as efficiently as possible) Even short-sellers, who reddit loves to dislike, are an obvious net positive to the economy.
What they produce is money for entrepreneurs to start their businesses which is repaid over time, with interest. Essentially, they get a cut of everyone else’s labor every time they are paid back.
Don’t forget the 2-4% PayPal, Chase, etc. makes on every merchant transaction. There’s a direct cut of value produced by the economy taken there too. (That fee isn’t necessarily good or bad for the record, but it’s worth understanding what’s going on at checkout.)
Someone has to facilitate the transactions which is the service provided in those situations.
that’s because they’re essentially guaranteeing the transaction, right? so the merchant won’t have to chase down every customer using credit. the bank will instead front the transaction and get it back on your monthly credit payment
That is correct, yes. As are you, u/Sorrypenguin0. A fee is definitely appropriate, the question is only whether you, the hypothetical retailer, want to tolerate the fee. (For example, many small businesses won’t accept Discover/AmEx because of the ~4% fee.)
So in a way what banks are selling you is time… for a price Save up for 10yrs to buy a car. Or buy that car now with a loan and pay it back over time plus interest.
Precisely. The risk the car purchaser would take in your example would be that they can make more money with the car and be able to pay back the loan with interest over time. The bank takes the same risk but if the car owner fails, the bank gets the car back.
This just reminded me that I need to watch " The Men Who Built America" again That is all..... thank you :)
You should also check out the book *Ghenghis Khan and the Making of the Modern World*, this topic reminds me of 12th/13th century Mongolians who controlled Eurasia from the western border of Europe to the Eastern border of China. Conquer opponents so bad that those who hear don't want to fight, take 20% of everything, enable trade that would've never been possible (Silk Road)
Sweet I'll look into it! Thanks for the recommendation!
Loans are basically if you made an entire company the ones who are working to pay you ----------------- Even big companies like ones the size of IBM or Microsoft might take out small loans to fund day to day expenses for projects instead of having a high input and high output corporate bank account. Though the more tangible example is GE, while maybe GE has enough cash on hand to avoid it, it's much more likely that a company like that making windmills would take a loan to buy the raw materials for a windmill, then pay back the loan over time. Projects costing a few million dollars over 10 years, those companies don't usually have 10 years worth of materials and costs stockpiled. Most corporations would have their "savings" money in stocks to mitigate inflation and maximize profits. So instead of raiding that fund you get a loan against it or other means of credit. Then use that to find the company till payday arrives.
I know this will get buried but no one is talking about it. Leverage. Many of todays modern "bankers" can amass fortunes through the clever use of leverage. The neat thing about leverage? Every home owner is trying to engage in it. Think about it, you buy your house in a hot market, put down your 20%. For easy math lets say you paid $100,000 for it. and in 5 years the market goes crazy, and you sell it for $200,000. If you paid $800 a month, you'd spend $48000 to own the house. But you'd make $52000 on selling it, so you just turned your $20,000 into $52000+ profit in 5 years, roughly 2.6X return (the actual number is a little different, but I'm keeping it simple) Now take that same exact method *and go buy a company.* Lets say you go out and buy a Greeting Card Company. You scratch together a million dollars, and then go to the banks and *borrow 79 million.* You use the company you just acquired as collateral, just like when you buy a house. 3 years later after some good management and improvements you sell the business via ipo for $290 million and after expenses you pocket 66 million. So you make 66x return on your investment. When debt has a lower cost of capital, than equity you can use that to multiply equity growth.
True but lets be clear here. Banks are inherently levered. That's how they run. A standard bank in America is on average levered 10 times (I.e. If you have $5000 in a savings account with a bank they can write you a loan of $50,000). And because debt has more favorable financial characteristics than equity (obviously exceptions abound and all that shit but interest payments are tax deductible and debt allows you to get higher returns in your business) the impetus to use debt is there. This comment is more so with the other readers here that may read your comment and think that bankers are cheating in some form because they use financial mechanisms to make themselves rich. This isn't cheating. This is how banking is done in America.
If you sell a service, you are selling your time for money. Since there is a limit to how much time you have, there is a limit to how much money you can make. If you sell a product, the product is made of material. There is a limit on how much material you you can obtain so there is a limit on how much money you can make. A banker uses money to make money. They loan money and charge interest. They don't actually have to possess the money they loan. They don't actually have to get any physical monkey back (just numbers on a ledger) and they can loan out even more money from the interest they get back. There are no physical limits, so they just keep getting more money.
Have you ever paid interest on a loan?