The Spread
Banking is rarely taught from the perspective of the bank. In most of our education, we learn how to use banks from a consumer perspective – our perspective.
While that is helpful, it is also good to know how the banking system works to become a very profitable operation with the help of your choosing to deposit and store your funds with them.
The banking business is based on something called “the spread”. The spread is the difference between what the banks pay you for your deposit and what they charge consumers who borrow from them. Loan rates will start from 5-6% and go up to credit card rates that can range upwards of 20%. This shows the bank is charging more on the money they are lending than they are paying you.
To paint a better picture of how banks are making money off of your money despite low interest rates, I’ll use an example.
Bank pays you for your deposit: 6%
Bank lends your money to someone else: 12%
The “spread” is then 6%.
Example: $100,000 deposited by Consumer A is paid $6,000 for their deposit.
The bank loans the $100,000 from Consumer A to Consumer B and receive $12,000 in interest.
The bank paid $6,000 to Consumer A and the gross returned was $12,000 – a 100% return.
There has been talk of how poor the banks must be and suffering through this period of low interest rates in which we currently live. I invite you to look at a more detailed example showing how this may not be the case at all. I’ll show you four more examples of how the banks are not suffering through low interest rates on lending.
Bank interest rate for deposits: 4%
Bank interest rate for lending: 10%
Spread is still: 6%.
In the above example for $100,000 deposited and subsequently lent, the bank now has a cost of $4,000 to consumer A but the return is 150%. (10%-4% = 6… 6/4 = 1.5)
Bank interest rate for deposits: 3%
Bank interest rate for lending: 9%
Spread is still: 6%.
The profit has now risen to 200%.
A new example – $50,000 deposited by Consumer A would be paid 1,500 and makes a loan from that $50,000 to consumer B charging 4,500 in interest returned. Bank paid $1,500 to consumer A but received 4,500 from consumer B. A gain of 3,000 or 200%.
Bank interest rate for deposits: 2%
Bank interest rate for lending: 8%
Spread is still: 6%.
The profit has now risen to 300%.
The rates may be applied to any numbers in any example and you can see how the profit margin for banks continues to grow despite low interest rates charged on loans.
Bank interest rate for deposits: 1%
Bank interest rate for lending: 7%
Spread is still: 6%.
The profit has now risen to 600%.
These examples show how the banking system and low interest rates work in favor for the banks. Banking can be very profitable which is one more reason to become your own banker.
When you’re ready to get started on creating your financial legacy or if you have more questions, most questions can be answered by watching this video. Start there and then schedule a consult with my team when you’re ready to begin.
