Banks and Your Money

Welcome to this week's newsletter. This newsletter and the next 2 will be dedicated to talking about Banks!

Why?

Because while the 2008 financial crisis is often blamed on the greed and irresponsibility of individuals and subprime mortgage lenders (people and companies that gave out loans to people with no or bad credit scores). However, I would argue that the true culprits of the crisis were the banks themselves.

These institutions, driven by the pursuit of profits, created a system of risky investments and financial products, that they knew were unsustainable. They then sold these toxic assets to unsuspecting investors. When the housing market inevitably crashed, the banks were left holding the bag and had to be bailed out by taxpayers, ultimately causing widespread economic turmoil and hardship.

In other words, the financial crisis was not a failure of the market, but a failure of the banks to act ethically and responsibly.

So, why talk about this now?

For those of you that follow me on Twitter, Instagram, Youtube and/or Linkedin (or my podcast), you know that the topic of Financial Literacy is extremely close to my heart. More so over the last few years after working for Mastercard, and working with over 1200 banks in US that cater to close to 10 million people, I knew that the whole system was rigged - well I already knew that but I saw it in practice.

So I thought, financial literacy should first begin with knowledge. Having as much knowledge as possible about how Banks make money (this newsletter), use and track you and your data (next week’s newsletter), and finally how they make money on investments (the week after next).  

How do Banks make money?

We all use banks to store our money and secure our financial future. But have you ever stopped to consider how banks make money, and what their true motives are when it comes to your finances?

Here are Four things you need to know about the banking industry:

1. How Banks use your Money to Make Money - Loans

Banks generate revenue in many ways, including charging fees for services, collecting interest on loans and investments, and by participating in various financial markets.

However, a significant portion of their profits come from the use of our money.

Banks take the deposits we make and use them to make loans and investments, generating interest for themselves. So while your checking account might be earning you a measly 1-2%, they are earning double digit interest on YOUR money.

For example, if a bank receives $100 million in deposits, it can lend out up to $90 million of that amount, keeping only 10% as reserve. This means that the bank can earn interest on the $90 million it has lent out, while paying only a fraction of that amount in interest to depositors.

2. How Banks use your Money to Make Money - Leveraging your Money

Banks use your money to make loans to other customers or non-customers, and the interest they charge on these loans generates profits (similar to #1).

But, what they are allowed to do is lend out more money than they actually have on deposits. For example, if a bank has $100 million in deposits, it can lend out $900 million, as long as it keeps 10% ($100 million) in reserve. This means that your money is at risk, as there's no guarantee that the borrower will be able to repay their loan, and if they default, your deposit may be used to cover the losses.

3. Not all your money is insured - you might actually be at risk of losing your entire checking account!

In the US, in any checking account, you might have, your money is (typically) ONLY insured up to $250,000. And this insurance is managed by FDIC - Federal Deposit Insurance Corp.

What this means is that if you have more than $250,000 in a bank account, and the bank collapses or goes bankrupt, you only get $250,000 back!

For example, if you had $1M in a bank account, and that bank went under, you would only get back $250,000 - you would lose the remaining $750,000!

This is why it’s always good to be Investment Rich and Cash poor! 

4. Why Banks push Credit Cards?

Credit cards are a big moneymaker for banks, as they generate significant revenue through interest charges, late fees, and transaction fees.

One of the most significant sources of income for banks from credit cards is interchange fees.

Interchange fees (swipe fees) are charged to merchants each time a customer uses a credit card to make a purchase, and the average fee is around 2% of the transaction.

So for example - for every $100 you spend, the banks earn between $1.50 to $2 on the credit card transaction.

But it is not the same for debit - Banks earn significantly more in interchange fees from credit cards than they do from debit cards, as the average fee for debit cards is only around 0.3-0.5%.

Based on the above, how do you think the Bank is going to allocate it’s marketing budget! Which type of card are they going to shove or showcase in front of you. Obviously the one that brings them more revenue, and the one that caters more to our human need for instant gratification and false sense of affordability.

And while, everyone is out on Instagram showcasing their latest car (on a loan), latest holiday destination (paid by credit), or the newest Louis Vuitton Bag (bought using a personal loan), Bankers are the one truly having the last laugh!

There is obviously a lot more to how Banks make money, and a lot more complex, but I at least wanted to give you an initial primer of exactly how they use your money! 95% of people don’t really know a lot of this, even the ones that work in banks or in financial services.

That’s all for this week, next week, I’ll talk about how exactly Banks are the true big brother, and know exactly who you are, where you spend your money, and how often (and more). I’ll even share an anecdote about how in my previous company, Security was so lapse, we would blatantly receive customer information from banks - something that was not allowed. Anyways - keep that for next time - part 2 out next week.!

Till then, continue to stay financially lit

Adi