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Money-making Economics

How Do Banks Make Money from Nothing?

Huge salaries and big bonuses get paid to bank workers. So, let's explain how banks make money from nothing!

MONEY-MAKING ECONOMICS: The banks appear to make big money from nothing. But how is this possible?

If that statement is true, how easy is it for the banking fraternity to make big money?

And what profitable banking rules and regulations do they follow to reward their highly-paid staff?

High street banks and commercial money lenders found a way to earn big profit margins.

They do so by lending large amounts of money to borrowers at higher interest rates than they pay their savers for kindly depositing it with them.

'Banks Earning Money from Thin Air - There are Risks and Rewards Attached!'

Savers: A Lender's Scenario

You live at number 10 Acacia Avenue, you have a good job, and no kids. But, you have very little funds left over each month from your salary.

You do not want to keep the banknotes under your pillow (please!) so you decide to 'save' £1,000 banked in the local high street deposit savings account for 12 months.

The bank staff workers are happy about this because they can give you £20 each year (2% simple interest rate) for every £1,000 that you save with them.

This is also called 'interest'. It is because the legalised money lenders get interested in 'borrowing' out your money. For example, monies invested in a deposit savings account get treated as if you are lending it to them. Thus, they make even bigger money on your nest egg!

Borrowers and Bank Loans

Fred down at number 20 Acacia Avenue is not as lucky as you. He works hard, but for less money than you. Fred has a couple of kids, a pet dog, and his car needs scrapping too!

How Do Banks Make Big Money From Nothing: Old Car for ScrapFred cannot lend the bank any of his income. That is to say, he cannot invest his spare money in a savings account.

He is fortunate to have an astute bank manager that agrees to lend him £1,000 at 4.5% APR. That means he can get his car fixed, feed the dog, and buy the kids the latest mobile phones that they want!

The bank agrees to lend him the funds for one year, providing he pays them back each month. He does so by working a bit harder and getting a part time job.

The bank charges ’interest’ on the money it lends to Fred. Why not? They have to pay you interest for the money they borrowed from you. That is to say on the deposit that you are ‘saving’ with them!

You are happy. You are getting £20 for the year by doing nothing. The bankers are happy because they have loaned your £1000 to him at an interest rate of 4.5%. At the end of 1 year they give you back your initial investment with interest.

At the end of the one year loan, he will have paid them around £1,103 in total! (Representative APR of 20.3%)

The financial institution gets rewarded with £83 pounds by borrowing from you and loaning to their lender. Banking sectors also make a great deal of their income from providing 'free' banking facilities' by way of current accounts.

One moment - I hear you say! How is it that the bank has got £103 by lending £1,000 for one year at 4.5%? The reason is because of something called ‘compound’ interest rate.

Compound interest rate could affect you with the money you save (loan) to them. It also affects the return that the lender has to pay back.

Even More Rewards for Banks

BUT... Fred will be paying even more than that. He may also have been 'sold' some form of insurance or payment protection scheme. That could get added to his original loan.

So his 'loan' could be nearer £1,100 even though he only received the amount he asked for. If this is the case, his loan would have been for £1,100 and he would have paid a total of £1214.

That is a financial reward of £214 that they have earned out of your savings (less the money they give back to you).

Your loan (savings) to the bank got put to good use by helping their customer with his short term problem. It has also introduced a tidy profit of £194 (minimum) into the UK Banking System.

How Do Banks Make Money from Current Accounts in the United Kingdom