How do banks cheat you?

How does a bank work and what does the bank do with my money?

You have probably asked yourself before:

How does a bank work?

An excellent question! What exactly does the bank do with my money?

She bunkers it for you absolutely foolproof in a huge underground safe with a large, shiny, round gate and complicated locking technology. Nuclear bomb-proof and video-monitored around the clock.

The bank is safe.



How does a bank work now?

Quite simply: it makes money out of my money. It reads weird, but it's true.

Do you really think that the bank will park your money for you in a safe in a safe and also pay you something for it (= interest)?

Let's not get silly. We all know that the bank is not the bloody welfare, but a perfectly normal company.

As such, it naturally wants to make a profit, like all of us.

And of course, most of the money is no longer in the form of bundles of banknotes in some sort of safes, but as bits on computers. Nowadays, a bank is usually more of an IT company.

What the bank does with your money is first of all: observe.

She gets a cup of coffee, sits down, looks closely, looks at the customer's balance and sees something extremely interesting:

Apart from the daily, numerous and small deposits and withdrawals, a large part of the customers' money remains in the custody of the bank most of the time.

Of course, this opens up very interesting opportunities for the bank. Because this money, which basically doesn't belong to her, she could actually lend for a fee.

For example, to companies, home builders and private individuals. Or they use it to buy stocks and bonds, even if banks are no longer allowed to do so to any extent.

That is exactly the principle on which a bank works. It lends or invests your money and collects interest for it. Let's take as an example 4% per year.

Of this 4% p.a., the bank now decides on you 2% per year to give you an incentive to park your money with her. Pretty clever, because it creates a win-win situation.

You have an advantage because you get interest on your credit balance and the borrower has an advantage because it gives them the opportunity to get money for their business.

Something like that is a fine thing for those who create this situation, because it is the basis of every functioning business model.

That is, the bank takes money from you, pays you interest and lends it on at higher interest rates.

So graphically, the bank does the following with your money:


Warning: This is all very simplistic and only corresponds to the bank's original principle. In reality, it's a little more complicated, but at its core, that's how it actually works.

Your money has to flow into the economy!

One of the most important findings in our world is that a person or a company can only make long-term profit if it provides people and society with sustainable benefits or added value. Point.

That is a law of nature.

Why it applies and what it means for us, we will take a closer look elsewhere. For now, trust me that this law exists and that it applies to all of us as does gravity.

What does this natural law have to do with the question of what the bank does with your money?

Quite simply: It explains why there is always such a big boom around banks in politics and the media. Hardly anyone likes them, but everyone needs them and no matter what screwed them up again: They do not cease to exist.

This is precisely because banks have such an important key position on the capital market. Whether you and I like it or not, they serve a very important purpose in doing so.

They ensure that those of us who prefer to park their money in an account instead of investing it do not withdraw capital from the economy. Money is like a raw material and therefore absolutely necessary for the economy. The bank takes care of the provision and distribution of this raw material.

I'm not exactly a fan of “the” bank either, but the fact is that it makes an important contribution to the economy. It helps that your money arrives where it is needed and can be productive:

In the real economy.

Where things, services and - generally speaking - benefits arise.

Eliminate the middleman

Okay, so we saw that it is inevitable, and almost inevitable, that our money go back into the economy.

As soon as we don't just bunker our money in the forest, it will find its way back all by itself.

The bank does just that and thereby serves an absolutely legitimate purpose in the economy. For this she is then rewarded with returns.

Because notice:

Only those who create added value for others will also get a return themselves.

We have already seen above what the bank does with your money. The bank is, so to speak, the link between you and the economy.

Now it is the case that every further middleman (= bank) makes a good (= money) more expensive (= lower interest for you).

Suppose we had direct access to the companies that would otherwise borrow your money from the bank. Then we could save ourselves the intermediate step through the bank.

For example, we could collect the 4% p.a. that the bank would otherwise collect. We could of course only charge 3% p.a. and in turn create a win-win situation for ourselves and the company that wants to borrow money. In this situation, both you and the company would be better off without the bank. In that way, you snatched the bank's business.

The best is:

You have access to the capital markets!

Today you can even buy stocks and bonds from any smartphone and manage your money independently.

And of course you get more returns with it than if you leave the money to your bank, which does with it what you should actually do yourself!

Take the bank's job of bringing your money back into the economy into your own hands and get paid for it!

Nowadays, in my opinion, banks mainly have the task of payment service providers.

You leave your iron nest egg on the bank and the rest is invested on your own.

What does the bank do with my money if it goes bankrupt?

If it ever happens that your bank is no longer solvent, then logically you have a problem first.

A look at the balance sheet of a bank also shows us very nicely what the bank does with your money as soon as the machine in the chic entrance hall in the branch feeds your bills or where your salary is posted.

On the left you can see the entire assets of the bank and on the right how the assets were paid.

She paid for some of what the bank owns out of pocket, but the lion's share is almost always financed with outside capital. This means that most of the bank's assets are paid for by others.

Who are these “others”?

You and me!

So what does the bank do with my money? She is making a fortune with it!

Wealth is anything that has value. In other words, buildings, furnishings, but also securities and above all: loans granted. Claims that the bank has against borrowers are also on the left.

And there we have it again, just like in the graphic above.

The bank takes on liabilities (with you) on the one hand and creates claims (for others) on the other.

That's it.

That's what the bank does with your money.

But now, in the event of bankruptcy, you only have one claim against the bank. Collecting these is usually possible without any problems in theory, but you certainly know about the history of theory and practice yourself.

There are various deposit protection funds and mechanisms that are intended to ensure that you get your money back safely and accordingly and that you have confidence in the banking system.

All nice and dandy, but I think none of us want to try out how well these systems work in an emergency.

Therefore, you should never deposit more in current or call money accounts than you really need. Again keyword iron nest egg.

What does the bank do with my money in the event of bankruptcy? Don't have it anymore. You have to take care of getting it back.

Have lots of fun with it.

How does a bank really work?

You may have heard some of what has been said so far in one form or another.

Maybe not so well prepared and explained how I do it here on Homemade Finance, anyway. 😉

That's why there is now a nice aha effect on top of this post!

The explanation of what the bank does with your money is no longer entirely correct these days.

Let's take our examples and our balance sheet from above.

If we assume that Equity (the little block on the right side of the balance sheet) of our bank 1.000€ and the total assets (left side) in the amount of 10.000€ consists of issued loans, the bank on those 4% p.a. gets and for the outside capital (= your deposits) 2% p.a. must pay, then the (raw) income of the bank is:

10,000 € x 0.04 - 9,000 € x 0.02 = 400 € - 180 € = 220 €

This corresponds to a return on equity of 22% per year.

220€ / 1.000€ = 0,22 = 22%

What does the bank do with my money? A good deal!

Now the resourceful bankers have found an interesting method to further increase the return on equity.

So far, we have always assumed that the bank itself holds the loans granted in its own portfolio during the entire term.

Nowadays, however, banks are increasingly putting their loans into securities and selling them to interested investors.

The proceeds from the sale are significantly higher than the interest that the bank would have received from holding the loan in the first year.

Let me briefly explain how this works. Don't worry, at second glance it is absolutely not complicated.

For this we assume that the bank lends your money as a single loan 3 year term further. You are the only saver of the bank and the entire fortune / loan portfolio / left side of the bank consists of that single loan. Credit and loan interest are again 2% and 4% per year. All very simplistic, I know. In essence, however, absolutely correct.

The bank has the classic option of keeping the loan itself and collecting € 220 every year.

On the other hand, it could also create a security from the loan and sell it to investors. The proceeds from the sale are equal to the discounted value of all payments from the loan relationship. For the sake of simplicity, we neglect the current market value and calculate a fair value for our security (minus the actual loan amount) of:

As a reminder, in our example the bank would have received € 220 or a 22% return on the first opportunity in the first year.

As a fairly priced security with a 3-year term, the bank's loan could € 660 at once bring in what is based on € 1,000 equity 66% return on equity this year corresponds.

660€ / 1.000€ = 0,66 = 66%

In relation to year 1, this is of course much more attractive for the bank. If you want to keep this return in the following years, you have to repeat the process every year and generate more credits.

Oh yes: Did I mention that the return on equity is one of the most important metrics on the basis of which the banker's annual bonus is calculated?

With this sleek idea, the banker now receives a fat bonus instead of three smaller bonuses over the next three years.

And because a banker is many things, but certainly not stupid, he prefers one big bonus today over several and at the same time smaller bonuses in the future.

This is really how a bank works these days.

Conclusion: what does the bank do with my money?

How does a bank work? It takes money as a liability to you on one side and thus creates wealth on the other.

The bank lives from the difference between the payment flows on both sides: money flows into the bank from the assets, money flows out (to you) from the liabilities.

What does the bank do with my money? It brings it back to where it belongs: In the real economy, where it is made available to entrepreneurs so that they can invent, build and do something great.

In short, the bank ensures that my money is not lying around unproductive, but has a use for humanity.

This is a very “noble” and important task and explains why banks have their raison d'etre. The fact that they may not be very popular in our eyes is another story entirely.

Unfortunately, you have to quickly say goodbye to the idea that your money is safely stashed in the bank (in the truest sense of the word).

But I think you knew that before.


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