Thursday, January 22, 2009

How banks use your savings

Was in a microeconomic class for this 4 days. The lecturer is amazing. He is a very dynamic person who just love to be himself. There is a lot that he had shared with us and I will like to share this on the blog.

Have you wonder how banks use your money and why did the banks in America collapse?

Here is the formula. All banks have a reserve ratio which is usually 10-15%. What does this mean?

It means, for every $1.00 you saved in the bank, they will only keep $0.10 in their bank! The rest are used by them to lend out with much higher interest and for their own investment. So it is to say your $0.90 are out there somewhere which they use for their own profits. Yes, this is what they do to your money. It makes one ponder how come the interest which they pay back to us is so bloody tiny. 0.25% -_-

This is the reason why the people in US is unable to take back their money as it is not there in the first place. All you see on your bank book is just a figure with no physical existence of the cash.

So why did the banks in America collapse? It is said that during the 2007 real estate boom, banks start to lend money to sub prime borrowers (people who does not have good credit). They thought that they will be able to make profits since the economy is so good at that time. Then came the real estate crash which left many of the debtors unable to pay back.
As a result, banks are unable to pay back to the people since there is only 10% of what is saved in the bank to begin with.

Interesting? haha to me it makes me think twice to invest in bank again. No wonder banks are so profitable.

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