Why are banks so rich?
― WhY ARE BANKS SO RICH?
― Categories:
I opened an account in a digital bank, and I went to my traditional brick-and-mortar bank branch to cancel my account there. Naturally, the manager asked me my reasons for canceling the account. I explained I didn't need two accounts and was keeping the one that didn't charge any fees (the digital one).
Once again, he naturally explained to me the reasons why I should stay with them. I thanked him and asked if he'd be able to exempt me from the fees. Of course, he said it was impossible for a bank not to charge their customers and that the fees were needed to keep the branches open (my personal opinion: I prefer solving bank matters over the internet. I only go to a bank branch if I must). Being an economist, I know his answer is wrong - well, it's a sales argument to try and keep the customer paying the fees.
Let's take the largest bank in the United States by assets as an example (you can Google to find out which one 😉). They have 18,5 million accounts as of 2023, and over 5.100 locations. Their cheapest monthly maintenance fee is $ 4,95. There are cases where you may pay more, there are cases where you may pay nothing (if you keep a certain amount of money deposited). On average, let's consider each of those 18,5 million accounts pays the $ 4,95. This means the bank makes $ 91.575.000 monthly, only by charging fees. This is about $ 18 thousand per branch, which might be less than enough to pay the bills.
Nonetheless, this is certainly a massive amount of money, but by far it is not the most important source of income. That same bank had $ 132.3 billion in income in 2022. This means that fees are only 0,07% of all the money the bank made over the year. Are you convinced already, or should I keep going? 😄
Let's simplify and pretend each of those 18,5 million accounts deposited $ 100 in the bank. This means the bank has $ 1,85 billion in deposits. There's something called reserve ratio - a percentage of all deposits must be kept by any bank during all the time this money is deposited with them. In the USA, this ratio is 10%. This means that for every $ 100 deposited, the bank must keep $ 10 during the duration of that deposit - the other 90% can be lent. Banks can keep more than 10% if they want to.
You didn't read it incorrectly. From the $ 1,85 billion, $ 1,66 billion can be redistributed in the economy. So the bank will get the same $ 1,66 billion back, plus interest. You see now how they make money? But this doesn't stop here. Let's say you get a loan of $ 100.000 to purchase an apartment. You pay this money to a person who will then deposit it in their account - with the same bank. So, the bank lent you $ 100.000 that came from customers, and the same $ 100 thousand returned to them and can be lent once more. It's a perfect loop, and it keeps going!
The money multiplier formula allows us to see the potential gains of a bank through deposits. It's calculated by dividing 1 by the reserve ratio. In the United States, it is 1 divided by 10%, which equals 10. Yes, you're reading it correctly. For each deposited dollar, banks can multiply it by up to 10. That is, the $ 1,85 billion in deposits can potentially become $ 18,5 billion, just like that. When I say potentially, it's because there are plenty of banks in the US - loans don't necessarily go back to the bank that lent the money.
If everyone decides to withdraw all their money at the same time from a bank, the bank most likely won't have all that money - as much of it is created on this money multiplication process.
Let's go back to the fees. In this simple example (deposits are much, much higher in reality), the bank would make at least $ 1,66 billion, and at most $ 18,5 billion. Money made from fees is only $ 91,57 million! Even in the worst-case scenario, almost twice as much money is made from loans than it is from fees. And we're not even including interest here - we all know how banks charge a lot for loans.
― Why are banks so rich?
Banks do make a lot of money with fees, but that's less than 1% of their gains.
A digital bank doesn't make money because they don't have physical branches, but because they can lend the money you deposit with them.
A bank must keep a part of all deposits made (it varies per country - currently 10% in the US) to guarantee their clients will be able to withdraw money at any given time.