The first thing you should know is that I am not a banking expert. I worked in that industry on a part-time basis while going to university. That was 20+ years ago. Currently, I am what you would call “just” a customer. I don’t have access to private banking, nor is my business significant enough for the executives at the banks to care about me. This primer on how banks makes themselves rich is based entirely on my personal experiences as a customer and my part-time job at ATB before moving into my current career.
Savings Accounts
Customer A: “I should start saving some money.”
Banker: “Great idea! We can put you into our Never-Fail, Best-Option savings account. It pays you interest. The more you have in there, the more you earn.”
Customer A: “I like earning interests on my money. I’d like to open one of those accounts please.”
Banker: “Easy-peasy-lemon-squeezy.”
The account is opened. The customer goes away. The banker has the customer’s money and is wondering how to make it grow. After all, Customer A was promised that interest would be earned on her funds. The banker certainly wasn’t going to pay the customer with money from the bank’s own pockets! A lightbulb goes on as the banker realizes that money can be made from lending. An idea begins to germinate. If the Banker only had to pay out a fraction of the interest charged to lend, then the bank would make buckets of cash!
But how to make that happen?
Mortgages
Customer B: “I need to borrow some money to buy a property.”
Banker: “I can help you with that. The interest rate on our mortgages is very fair.”
Customer B: “That sounds good. Where do I sign?”
The banker is gleeful. Two customers! One brings in the money to be lent to the second. The bank only has to pay Customer A an interest rate that is a tiny portion of what’s being charged to Customer B. The difference between the two rates will be spent on administrative costs & other expenses, but any leftover is profit. How many other ways could the Banker come up with to make money?
Lines of Credit
Customer C: “I’d like to borrow money, but I’m not sure when or how much I’ll need.”
Banker: “Not a problem. We’ll set aside some money just for you. If you don’t use it, then there’s no charge. If you do use it, then the interest rate will be the prime rate + 3%. We’ll start charging you interest from the minute that you use your line of credit, but you only have to make the minimum monthly payment. You can pay it off whenever you want to.”
Customer C: “Awesome! Thank you!”
Auto Loans
Customer D: “I want to borrow money to buy a new vehicle.”
Banker: “I can help you with that. We’ll secure the loan with the vehicle. If you don’t pay the monthly note, we’ll repossess it.”
Customer D: “Sounds fair. Thanks!”
Credit Cards
Customer E: “I’d like a credit card please.”
Banker: “Done. Now, it charges a double-digit interest rate.”
Customer E: “Double-digits? That’s kind of expensive!”
Banker: “You know what? You’re right. So I’m going to do this for you. We won’t charge you any interest at all so long as you pay off the full balance when the statement is due. Think of it as a grace period. If you don’t pay it off in full, then I’ll charge you interest… and other assorted fees for late payment.”
Customer E: “Okay. Can I have my credit now please?”
Service Charges
The Banker wants to make even more money. The spread between interest paid on savings accounts and the interest earned on mortgages and other debt products is pretty good… However, the Banker is convinced that there is a way to increase its profits. Customers had always paid for drafts and certified cheques, but those instruments were often rare and not guaranteed income to the Banker. In a world of electronic transfers, fewer and fewer people need such services. Yet, everyone still needed to pay their bills, send electronic transfers to each other, make loan payments, and clear cheques.
Banker: “I could charge them just for having an account! Or I could offer them a so-called free account, but charge them by the transaction. People are inherently lazy about switching banks. I might lose a few customers but most of them will stay with me…and will pay me every single month to use their own money!”
The Banker add service fees to its bank accounts. Presumably, these are to cover the costs of providing services like utility payments. The Banker tell people they can pay per transaction, or they can pay a flat monthly fee for unlimited transactions. Better yet, customers can leave several thousand dollar in their account at all times in order to have the monthly fee waived completely.
Customers: “This sucks!”
Banker: “What are you going to do?”
If you’ve ever wondered…
…how banks make themselves rich, I hope this post gave you some insights. Banks make money because they have a vested interest in getting customers into debt. They profit when people borrow money. That’s the heart of their business. Everything else is a detail.
The vast majority of us will need to borrow money at some point. Assuming you’re interested in paying as little as possible to do so, here are some things to consider:
- never carry a balance on your credit cards;
- take advantage of prepayment options to pay off your mortgage faster;
- switch to banks that don’t charge service fees;
- when you know you’ll be making a big purchase, save the money first before spending it.
And should you be in a position where you cannot avoid owing money to the bank, then do yourself a small favour. Start buying shares in the banks! In Canada, banks pay out dividends every single quarter. Their profits are going up and their shareholders are benefiting. If you become a shareholder, then atleast some of the interest and fees that you pay is coming back to you every year. After sufficient period of time, all of the money that you’re paying to the bank will be returned to you in the form of annual dividends.
Now you know.