In my last column I left for your pondering some fundamental questions about the day to day “business” of the bank. To keep it simple, just use the bank that you regularly do business with so as to make this exercise a tangible one for you. It is really quite worthwhile for you to take the time to understand this. It will for sure, change your mind about many things as far as banks are concerned. It may have even deeper implications for you and your financial future. I mean, that’s what financial literacy is all about; using the knowledge to empower your own actions to make better financial decisions!
For example, in my last post I asked the question “Is it better to be a loaner or an owner of the bank you do business with?” What exactly is the business of the bank? What does the bank do with the money I deposit in my account? How do the banks make a profit? Can I share in the profits of the bank? I have asked these questions to many people over the last thirty years and you would be surprised at the number of MBA’s and other academic and
business types that cannot give me an accurate answer to the previous questions. The bank pays you a lower rate of interest to use your money to lend to others at a much higher interest rate. Let me explain using the K.I.S.S. principle, which means Keep It Simply Sweet. Take for instance that they pay you one percent to guarantee your deposit funds for one year at the bank. Then they lend out your funds out at say three percent for one year in a mortgage for example. The return is NOT two percent, the return is two HUNDRED percent.
That is NOT an error. Check the math. That is gross profit. If the bank lends your money to their credit card customers at twenty four percent per annum in unpaid balances, the return is twenty-four hundred percent. This is a simple explanation of the term “spread” which just happens to be the difference between what banks earn on the money you lend them.
Any wonder why the big five banks made almost thirty two billion dollars in profits last year?
Yes my friends, they use your money to get rich! The owners of the bank get to share in those profits after they pay all expenses and taxes associated with making their revenues. And the dividend income that the shareholders earn from all of this profit is taxed less than the tax the depositors pay on the interest income they earn for lending the bank the money.
Just wait till next week as I have a really big secret to bring to your attention about other bank made rules about making profits for the shareholders. The big 5 Canadian banks generated profits exceeding $31 Billion. Next week we will discuss how easy it is to share in that profit and not worry needlessly about “risk”.
Copyright 2013 Richard M. Kiernicki. All Rights Reserved.
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